WT News: Market Share

Federal IT services market has strong fiscal finish

Bill Loomis

After being outperformed by commercial IT services companies and the S&P 500 in the first half of the year, federal IT services companies outperformed both in the third quarter and continued their momentum into the fourth quarter.

Federal IT services companies are up 12.9 percent this year, compared with the 6.9 percent gain from the commercial IT services companies and the 1.4 percent gain of the S&P 500. BAE Systems PLC's purchase of DigitalNet Inc. and an uncertain commercial tech-spending environment, along with continued solid earnings from the federal IT companies, have enticed investors back to the federal IT stocks.

As third quarter earnings reporting winds down in the federal IT services industry, the numbers have been largely at or above our revenue and earnings estimates. The average internal growth rate so far for the third quarter is 16.3 percent, up from 15 percent in the second quarter and 14 percent a year ago quarter. (SRA International Inc. is the only company that has not reported as of press time.)

Federal IT services companies gave positive forecasts for the fourth quarter and next year, though there was not much change from current expectations, which already have been positive. All of the companies indicated they believe the civilian budget delay will have a minimal impact on their businesses.

Also, most believe that the presidential election outcome will have little impact on defense and federal IT spending. Shares of the public federal IT services companies are trading at 20 times my 2005 earnings projections, back to the valuation that they enjoyed at the beginning of the year, but still below the 27 times peak reached in 2003.

The public federal IT companies that have been posting strong results continued to do so, while companies that have had difficulties in the past year had a positive outlook. Anteon International Corp. posted earnings-per-share growth of 31 percent on 14 percent organic revenue growth. CACI International Inc. posted very strong 50 percent EPS growth on 23 percent organic revenue growth, as did SI International Inc. with EPS growth of 44 percent and internal revenue growth of 32 percent. MTC Technologies Inc. had 20 percent EPS growth on 6 percent organic revenue growth.

Dynamics Research Corp., PEC Solutions Inc. and ManTech International Inc., three companies that had difficulty meeting earnings projections over the past year, reported being on target or ahead of their guidances. Although DRC's EPS was down 7 percent year-over-year on only 6 percent organic revenue growth, it met expectations and gave guidance of improved growth and margins in the fourth quarter.

ManTech's reported EPS was down 17 percent in the third quarter from a year ago, though organic revenue growth was a healthy 12 percent. ManTech also gave an improved outlook for the fourth quarter, with revenue and EPS expected to be better than consensus estimates.

PEC reported flat EPS growth in the quarter and 4 percent organic revenue growth. However, investors seem enthused by the company's upbeat guidance for 2005, based on a recent uptick in its contract wins. Overall, the business outlook stays strong in federal IT services. n

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.

About the Author

Bill Loomis is a managing director at Stifel Nicolaus.

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