Bill Loomis (firstname.lastname@example.org) is a managing director at Stifel Nicolaus. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation or needs of individual investors. For additional information and current disclosures for the companies discussed herein, go to the research page at www.stifel.com.
Why have federal IT service stocks been so weak this summer? It's a question many investors and companies have been asking me.
Investors' trepidation about slowing IT budget growth has prompted a drop in stocks of publicly traded federal IT companies. And it's no help that there is weakness in the overall stock market over concerns of rising interest rates and oil prices hurting global economic growth.
Results in the federal IT industry have been dampened by the late passage of the fiscal 2006 defense bill, and more recently have taken a hit from the delay in the defense supplemental spending bill.
Over the past year, federal IT service stocks are up by 18 percent, above the 9 percent from the S&P 500 and the 17 percent from commercial IT service companies. Looking to the future, as contract activity improves through the year, and mergers and acquisitions inevitably are announced, federal IT stocks may trade higher.
Federal IT services stocks have been up following the past month's fourth quarter earnings reports. Quarterly results and the near-term outlook were not exciting for investors, but contract awards seem to be picking up. Most of the public federal IT service companies are expecting accelerated growth in revenue and earnings per share.
The budget delay and moderating growth rates of federal IT services companies contributed to the failure of their stocks to keep pace with their earnings growth last year.
Public federal IT service companies in general reported third quarter 2005 results in line with their guidance ranges, but fourth quarter 2005 revenue guidance for most of those companies was lighter than most investors expected.
Most public federal IT service companies have reported third quarter earnings, and results have been better-than-expected earnings per share with mixed performance on revenue.
Federal IT service stocks trailed off in the past month, following concerns that emergency funding for hurricanes Katrina and Rita would pressure federal IT budgets. Supreme Court hearings, Katrina investigations and other issues also have delayed fiscal 2006 spending bills.
The federal IT services industry has seen a lot of merger and acquisition activity, and I expect it will continue. Several factors are driving this activity: the industry's size, its high degree of fragmentation with no truly dominant players, relatively low total-market growth, good access to capital and strong free cash flow.