Cubic (CUB) is a very interesting company, yet it operates under the radar, as a provider of various innovative solutions. The company is positioned in a very compelling way but could use some higher margins as I like the long-term prospects and potential of the business. This means that current earnings multiples are a bit expensive, and I am not pulling the trigger yet despite a 30% pullback seen from the highs of this summer.
A Quick Overview
Cubic offers innovative solutions across basically 3 fields of expertise: transportation systems, mission solutions and defense training, as those activities combined bring in little over a billion in annual sales. All these solutions have a common understanding: that of providing integrated solutions to increase situational understanding in both commercial and defense environments.
The company is certainly a global player with little over half of sales generated abroad. While two of the three businesses focus on defense related tasks, they combined are about as large as the transportation systems business.
Having reported pro forma sales of $1.1 billion in 2017 (adjusted for a divestiture), the company has set aggressive goals for revenues to grow to $1.40-1.45 billion, while adjusted EBITDA margins are expected to rise from 8% in 2017 to 11.0-12.5% by 2020.
M&A plays an important role in achieving these ambitions as Cubic has a real track record of acquiring small and promising technology companies while integrating them successfully into the business. Having consistently paid out dividends since the early 1970s, long-term investors have seen very decent gains. Note that this was just a $1 stock in 1980, traded at $7 in the year 2000, and after having peaked at $77 this past summer, it now trades at $53 per share.
About The Valuation
On November 19, Cubic reported its results for the fiscal year of 2018 which closes a little sooner than the calendar year, of course. Revenues were up by 9% for the year and final quarter, with sales amounting to $1.20 billion last year.
Adjusted EBITDA for the year rose by nearly 20% to $104.6 million, equal to 8.7% of sales, up a full 80 basis points on the year before as the fourth quarter is typically very strong for Cubic in both sales and earnings.
Note that the reconciliation item list for the adjusted EBITDA number is both large and sizeable. Of course, we have to adjust for $47 million in D&A expenses, creating an adjusted EBIT number of $58 million. That even kindly excludes about $35 million worth of “strategic” IT investments and a few million of deal-related expenses and restructuring costs.
Holding $129 million in cash and equivalents and $217 million in debt and pension related liabilities, net debt amounts to $88 million. It should be noted that leverage ratios are quite modest. Assuming a 4% cost of debt on net debt, and working with a 25% tax rate, I end up with an adjusted net earnings number of $40 million. With roughly 27 million shares outstanding, that works down to earnings of around $1.50 per share, which means that expectations have risen quite a bit, as this is even just an adjusted earnings number.
About 2019
For the current fiscal year, the company sees healthy growth with sales seen at $1.37-1.45 billion, while adjusted EBITDA is expected to rise to $135-155 million, for margins just in excess of 10%
At the midpoint of the guidance, that works down to $145 million in EBITDA, which results in roughly $95 million in adjusted EBIT. Similar assumption on interest, taxes and $50 million in D&A allows for adjusted earnings of $68 million, or about $2.50 per share.
That is a bit too simplistic as the company acquired Trafficware late October in a $236 million cash deal. Trafficware is an IoT software and hardware provider of intelligent traffic management solutions. The business generates just $50 million in sales but is highly profitable with adjusted EBITDA contribution seen at $14-15 million per year. Note that most of the deal will be paid for with stock as the company arguably believes its own valuation is a bit rich, having sold 3.8 million shares at $60 at the end of November, for gross proceeds of $228 million.
That means that the share count rises to roughly 31 million shares going forward, as leverage ratios remain very modest just below 1 times. The company had the option to pay for this deal with debt. Instead, management opted for payment in equity. Based on the $68 million potential earnings this year, I see earnings at around $2.20 per share.
Despite a 30% pullback from the highs of the summer, shares remain expensive at still 24 times earnings!
The Latest Addition
With 31 million shares trading at a $1.6 billion equity valuation and little over $1.7 billion valuation on an enterprise basis, all of Cubic trades at roughly 1.2 times sales and roughly 12 times EBITDA.
At the start of the new year, the company announced another bolt-on deal, as it is acquiring Gridsmart Technologies in an $87 million cash deal. With the deal, Cubic acquires expertise in video detection at the intersection of advanced image processing, computer vision modelling, and machine learning, with the purpose of optimising the flow of people and traffic.
The deal adds $35 million in sales and $8 million in adjusted EBITDA, working down to very reasonable multiples, especially given the growth profile of the business given its positioning. This is the second deal in a row which adds more expertise and sales to the transport management systems. While net debt could essentially double to roughly $180 million following the deal, that still marks for very modest leverage ratios, providing more than enough firepower to make similar bolt-on deals in the quarters to come.
With multiples looking quite nice, reality is that the deal represents just 5% of the enterprise valuation of Cubic, marking just a modest addition which will not move the needle in a big way.
Great Business, Still Expensive
Working with a $2.20 earnings per share number this year, and leverage being relatively modest, valuations are still relatively expensive at $53, for a 24 times multiple. It should be said that Cubic is very well positioned and should deserve a modest premium to the market, at let’s say 20 times earnings, which means the shares still need to drop about $10 from here to provide a real compelling buying opportunity.
The promise of the company is to deliver on its 2020 goals with EBITDA more or less seen around $170 million at the midpoint of the guidance. After including $55 million in D&A charges and some $10 million in interest expenses, I see room for earnings to expand to roughly $2.50, or perhaps $3.00 if the company does really well in the coming years. That sounds compelling but is not enough for me just yet to buy the 30% pullback seen already, as I only see appeal emerging below the $50 mark.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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