Market Share: Wild ride doesn't dampen federal IT stocks

Bill Loomis

Olivier Douliery

It has been a wild ride for the publicly traded federal information technology services companies. In one day alone, following lowered expectations by PEC Solutions Inc., the federal IT companies were down 10 percent as a group.

Even before PEC's news, the industry's stocks were under pressure from the stock market's negative performance, the impact of a potential war with Iraq and the long-delayed fiscal 2003 civilian spending bill.

Despite these concerns from nervous investors, the federal market outlook still appears positive with growing budgets and strong company earnings reports.

The federal IT budget over the next two years looks good, though the rate of defense spending is expected to slow from the record increases in the fiscal 2003 budget. President Bush's fiscal 2004 plan is to increase federal IT, both defense and civilian, by 12 percent to $59.1 billion (from an unadjusted base of $52.6 billion), higher than the 8 percent increase in fiscal 2003.

Even adjusting for about $1.6 billion of work that was also done in fiscal 2003 but not counted as IT, the growth is a strong 9 percent. The two overall winning budgets appear to be the Department of Homeland Security, which is expected to have a 7.4 percent increase in its budget, to $36.2 billion, and the defense budget with a 4 percent increase.

For companies that have reported their fourth quarter earnings for 2002, the results have been strong. CACI International Inc., SRA International Inc. and SI International Inc. all reported better-than-expected results and have a favorable outlook for 2003.

While industry high-flyer PEC Solutions reported a slightly lower-than-expected outlook for first quarter 2003, sending its shares down 33 percent in a day, it is still looking for 13 percent to 23 percent earnings-per-share growth for the year.

However, each company has concerns about the potential negative impact of a war with Iraq and the delayed fiscal 2003 civilian spending bill. The federal government subsidiaries of Affiliated Computer Services Inc. and Computer Sciences Corp. also reported growth, though below that of the smaller, pure-play companies.

ACS reported that its federal business grew 11 percent to $211 million, 23 percent of ACS' total revenue, in the quarter, with 8 percent internal growth and 3 percent acquisition growth. For CSC, federal revenue was up 7 percent in the last quarter and is 28 percent of total revenue.

Federal IT companies offer investors good growth and cash flow, as well as solid balance sheets in a very difficult economic and investing environment. I estimate federal IT companies will show strong double-digit earnings-per-share growth this year, an impressive feat in such a tough market and economy.

Specifically, for 2003, I expect earnings-per-share growth of 21 percent from Anteon International Corp., 17 percent from CACI, 33 percent from Dynamics Research Corp., 10 percent from ManTech International Inc., 29 percent from MTC Technologies and 18 percent from SRA. This growth is before acquisitions, and last year all the aforementioned companies did accretive acquisitions, with the exception of Anteon, which did not make an acquisition in 2002.

Overall, despite the stock price weakness, the federal IT companies are continuing to outperform their commercial counterparts in terms of earnings growth and outlook. *

Bill Loomis is a managing director of the Technology Research Group at Legg Mason Wood Walker Inc. He can be reached at wrloomis@leggmason.com. 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, please write to Legg Mason Wood Walker Inc., 100 Light St., P.O. Box 1476, Baltimore, MD 21203, Attn: Research Department.

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