Based in Andover, Mass., Mercury (ticker: MRCY ) specializes in electronics and chips for the aerospace and defense industries for the U.S. and its allies. Mercury has more than 300 programs with 25 defense contractors, and its products are found in the F-16, F-18 and F-35 fighter jets. Hunter and Reaper unmanned aerial vehicles; And
(RTX) Patriot air-to-air missiles, to name a few.
Where it once specialized in simple circuits, switches and sensors, Mercury Systems has been moving up the value chain from components to complete subsystems. The company has made 14 acquisitions since 2016, including aircraft display systems, radio-frequency components, damaged computers and servers, and flight control units.
On paper, Mercury’s plan is to combine various components into larger subsystems to sell to its defense contractor customers – increasing sales and profit margins.
“It’s a good strategy because when you’re a subsystem supplier, it’s a much stickier business than selling individual components,” said Randy Gwirtzman, co-manager of the $1.4 billion fund.
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Fund (BDFFX), which owns shares of Mercury. “So it was a good game – it just didn’t go as well as we thought.”
Mercury may have bitten off more than it could chew, with Covid-19 supply chain disruptions exacerbating the situation. Earnings in the last fiscal year fell 54 percent, to an adjusted $1 a share, while revenue was nearly flat, at $974 million.
Mercury stock, meanwhile, has fallen from a high of $92.80 in April 2020 to $44.74 by the end of 2022. In June, the company’s attempt to sell itself dropped to $31.50 on the orders of activist investors. and Jana Partners, ends without agreement.
That’s when the new administration comes in. Jana pushed Bill Ballhouse, an aerospace engineer trained among several major defense contractors, to be added to Mercury’s board last year. He took over the CEO and president roles on an interim basis in June, positions the company made permanent last month.
Mercury also has a new chief financial officer — David Farnsworth, formerly of Raytheon — and several new board members. It will be their job to turn around stalled programs while tying up resources in development and weighing in on gross profit.
| Headquarters |
Andover, Mass |
|---|
| Latest price |
$37.99 |
| 52-Wk change |
-20.2% |
| market value (car) |
2.2 dollars |
| 2024E Sales (ml) |
976 dollars |
| 2024E Net Income (Millions) |
$77.8 |
| 2024 EPS |
1.33 dollars |
| 2024 E. P/E |
28.6 |
E = estimate. Note: The fiscal year ends in June.
Source: Bloomberg
“[Ballhaus] He comes in after a year on the board with extensive experience in executing change and driving shareholder value, and is highly aligned with shareholders with his compensation plan, he said. Jana and a Mercury board member since July.
Ballhouse calls fiscal 2024 a “transition year,” with earnings and cash flow improving over time. “In my experience, that’s not common in fast-growing businesses through acquisitions,” he said on the company’s fiscal fourth-quarter earnings call in August. “At Mercury, the immaturity and lack of full integration in key functional areas has led to severe challenges to the company’s forecast performance over the past several quarters. That said, maturation in these areas is possible, within our control and ongoing.”
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Those operational improvements should start showing up in the numbers in the coming quarters. Sales won’t grow much in the new fiscal year — management guidance calls for revenue of $950 million to $1 billion in fiscal 2024, and the Wall Street analyst consensus split the difference — but profits are forecast to rebound 33 percent, to $1.33 a share. This is due to the tight integration and control of operations and other cost-saving measures that Mercury has achieved, which will help lower costs by $21 million and improve profit margins for the fiscal year, the company said.
But the key to turnaround is getting troubled programs back on track. Just 20 programs cut $56 million from Mercury’s fiscal 2023 adjusted earnings before interest, taxes, depreciation and amortization, or EBITDA, which would have been $188 million without them.
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Those programs have been a drain on cash flow due to inventory accumulation. The company’s working capital increased 65% of revenue last fiscal year, up from 35% in fiscal 2020. – When it starts generating sales, Mercury can release that working capital into free cash flow. Margins should also expand, and management is targeting a return to low-to-mid-20% adjusted EBITDA margins “over time” – in their words – after an increase to 14% in fiscal 2023.
The market doesn’t seem to give much credit to Mercury’s ability to think and evolve in closed engineering ways. Shares, at $37.93, currently trade for 28 times trailing 12-month earnings, a discount to the 30-plus times they received in 2019 and 2020, though it should be profitable. It wasn’t that long ago that Mercury was churning out double-digit earnings and troubling the market and the stock performance of its peers.
It’s not hard to imagine a world in which Mercury matures — and if it does, stocks could double over the next three years, especially if they follow earnings growth and regain their premium price multiples.
Growing up can be a pain, but for the accumulation of mercury systems, it should be worth it.
Write Nicholas Jasinski at [email protected]
