Description

CACI, Inc. checks a lot of boxes for the kind of business one can own for the long-term and sleep well, regardless of the interest rate environment or geopolitical chaos.  The company is well-positioned for the uncertain geopolitical environment we’re facing, offers the attractive combination top-line growth AND margin expansion, limited cyclicality, a strong balance sheet, a competent management team, and trades for a below-market multiple despite its growing backlog.  CACI hasn’t been written up on VIC in almost nine years and today offers an attractive place to invest capital for long-term oriented shareholders hoping to dodge some of the more volatile mine fields in today’s market.

Company Background

CACI provides consulting and technology services, primarily to the U.S. defense and intelligence agencies.  Their services support national security missions and the modernization within the intelligence, defense, and federal civilian sectors.  CACI talks about its business in terms of providing two basic kinds of services: Expertise and Technology. 

Expertise services include software development, data and business analysis, and IT operations support for internal agency operations.  Specific examples include naval architecture, marine engineering, and special ops / intelligence support.  Technology services include Network and IT modernization, ERP systems, electronic warfare, cyber operations, and radio frequency and 5G spectrum awareness, agility, and usage, among many others.  The Department of Defense is CACI’s single largest customer, comprising roughly 70% of revenues, with federal civilian agencies accounting for the bulk of the remaining business (domestic intelligence agencies, DoJ, Dept. of Agriculture, Dept. of Health and Human Services, and State Dept.  There is a small international business, but it is not material to the story.

The investment case for CACI today consists of five basic pillars:

Budgetary & Geopolitical Tailwinds

As a company effectively reliant on one customer, the budgetary environment plays an outsized role in the industry's contracting trends and activities, and CACI adjusts their strategies to take this into consideration at all times.  Of the total ~$1.5 trillion in discretionary funding in the US’s 2022 budget, $782 billion was earmarked for defense – a figure that represented an increase of 5.6% over the previous year.  The 2023 budget has not yet been finalized (on Septemeber 30th, Congress passed a CR extending government funding through December 16th, 2022 at last year's spending levels, but all indications are that the budget for defense spending is going higher.

The current geopolitical backdrop has resulted in continued strong demand and bi-partisan support for national security and modernization priorities.  As the 2023 budget is currently moving through Congress, the company is seeing favorable indications: higher spending on defense, intelligence, and homeland security.  This results in higher spending in key addressable areas for CACI (Digital Solutions, Enterprise IT, C4ISR, Cyber, and Space).  CACI is a direct beneficiary of what looks to be an attractive defense spending environment for years to come.  The conflict in Ukraine, volatile energy markets, and rumblings in China all work in CACI’s favor.

Healthy Financial Profile

CACI has a consistent track record of mid-single-digit organic top-line growth, and has supplemented this growth with bolt-on acquisitions (eight over the past three years) to achieve a 9% CAGR over the past five years.  The runway for additional M&A is long despite the higher rate environment and management has shown itself to be a disciplined acquirer in an industry with a generally robust M&A pipeline.  Leverage currently sits at a modest 2.3x LTM EBITDA.  The strong cash flow profile of the business offers management significant optionality to deploy capital flexibly and opportunistically as events unfold in the world.

Ex-goodwill, the ROIC profile of the business is extremely attractive (30+%), but is a more modest (but stable) HSD% when including goodwill.  However, much of the $4B in goodwill on the balance sheet was invested many years ago, and the current CEO has been in the role only since 2019.  To the extent that he deploys capital into M&A more effectively than his predecessors, this number could move higher over time.

Attractive Near-term Earnings Outlook

The limited cyclicality of CACI’s business is particularly attractive in an environment where changing interest rates and the Fed’s tightening moves have dramatically impacted the near-term demand picture for a large swath of the market.  The bi-partisan nature of support for near-term defense spending, coupled with the geopolitical tailwinds mentioned above, provide an increasingly rare healthy outlook for earnings in the current market.

Impressive Management

John Mengucci has served as CACI’s CEO since 2019 and has done an excellent job managing the business while investing ahead of customer needs in a wide variety of different areas.  He focuses squarely on free cash flow per share as his preferred metric for business performance, and owns close to $30mm in stock.

In March of 2021, the company entered into an ASR with JPMorgan and repurchased 2m shares of stock.  On the Q1 2023FY call, the company acknowledged that the M&A pipeline isn’t quite as robust currently as it has been in the past.  The debt paydown and the recent working capital management has been similar to the period in early 2021 when the company launched its previous ASR.  Perhaps I'm reading too much into management's comments on the most recent call, but it seems another ASR could be a possibility in the near-term, given the current M&A environment, strength of the balance sheet, and earnings backdrop on the business.  In either case, Mengucci stresses that he intentionally avoids the word “balanced” when it comes to capital allocation, preferring to act opportunistically in response to changing conditions on the ground. 

Undemanding Valuation

CACI currently trades at ~16x forward year estimates, compared to peers that trade closer to 30x and to the S&P 500 forward year P/E of 19x.  This is too cheap, given the stability of CACI’s business, the optionality afforded by its strong balance sheet, and the company’s near-term earnings outlook.  It's also worth nothing that less than two months ago, the Carlyle Group completed its acquisition of a direct competitor, ManTech International, for $4.2B, or 26x earnings.

Risks

Investors tend to worry about government budget headwinds with these businesses, particularly around elections.  But congressmen and congresswomen on both sides of the aisle are unusually united in the support for Ukraine, and this bi-partisan support is very likely to lead to higher expenditures on defense.

An unusually tight labor market presents the possibility of higher wage costs and margin degradation, but management pointed out on the most recent call that 60% of CACI’s revenue is cost-plus, and on these contracts higher wages get passed along to the customer.  For the remaining fixed-price contracts, CACI’s projects are significantly diversified and management has a strong track record of keeping those costs in check and achieving margin targets.

M&A activity always introduces risk, but transformational M&A appears to be off-the-table and any activity is almost certain to be limited to the kind of small, digestible transactions CACI has been executing successfully.

In sum, CACI is an attractively priced, non-cyclical business with a healthy near-term outlook, a growing backlog, a strong balance sheet, and a history of organic top-line growth driven by new customer wins and on-contract growth.  Management has an established history of consistent value creation and broader geopolitical tailwinds are currently very favorable.  I believe the appetite for these types of businesses is increasing significantly as investors continue to acclimate to the new rate environment sector volatility within the market.

Catalyst

- Finalization of US 2023 fiscal year budget

- Continued stable top- and bottom-line growth

- Accretive M&A