Leidos Holdings, Inc.

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 4/5

Leidos Holdings, Inc. is a large government contractor that provides services in the areas of defense, intelligence, civil, and health, offering tech solutions, systems integration, and other professional services to various U.S. government agencies and other commercial customers worldwide.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Leidos operates across four primary segments: National Security & Digital, Health & Civil, Commercial & International, and Defense Systems. Each segment is tied to specific areas of operations and is responsible for their profit and loss performance.

Business Overview

Leidos is primarily a government contracting company with a global reach, working with numerous U.S. government agencies and various commercial and international clients. It has a diverse operational portfolio, focused on the following: * National Security & Digital: This segment delivers solutions in cyber security, intelligence, and operations related to national defense, homeland security, and intelligence gathering to a broad variety of government clients. * Health & Civil: Focuses on healthcare solutions, clinical research and operations, public health infrastructure, and technology solutions. * Commercial & International: This segment provides technology and services to commercial and international customers in diverse industries. * Defense Systems: This segment delivers defense-related products and systems that include air, sea, land, and space defense systems for different government clients.

The company’s diverse portfolio across various segments enables it to capture more government contracts and have the expertise to pivot its business when it needs to. Leidos’ revenue stream is largely diversified across various industries.

The sectors Leidos operates in, particularly defense, intelligence, and health, are characterized by consistent government spending, long-term contracts, and high levels of technical requirements. These conditions can produce a stable revenue stream, and higher barriers to entry.

  • Defense: High barriers to entry include regulatory compliance, security clearances and established relationships with government agencies. Contracts are large, often multiyear, and require intense project management skills. Companies in this space are generally large contractors, and are often oligopolies or monopolies due to the nature of these contracts.
  • Intelligence: High level of intellectual property and security clearances require firms to have very specialized expertise. Similar to Defense, they also have long-term, large contracts with large government spending.
  • Health: In this segment there is great deal of regulation and government spending. Companies need very specific knowledge in healthcare to participate in this industry. Large contracts with hospitals and other healthcare providers, require specialized understanding of healthcare regulations and processes.
  • Commercial: In the commercial and international sector, large players can compete in specialized segments, but low barriers to entry allow smaller companies to take some market share. Companies in this industry must continuously compete on the basis of innovation and brand to acquire new customers.

Leidos differentiates itself through advanced technology, specialized talent, long-term government relationships, a large-scale operation, and an ability to provide end-to-end solutions in multiple sectors.

Moat Analysis

Leidos possesses a narrow moat rating of 3 / 5.

  • Intangible Assets: Leidos benefits from its large number of personnel with high clearance ratings, its knowledge of government contracts and bureaucracy, and its reputation in different industries. In particular, their brand and expertise in the defense and intelligence space is their biggest intangible asset.
  • Switching Costs: Companies like Leidos tend to have decent switching costs. The reason being that they become tightly intertwined in the client’s business processes. Replacing or switching contractors in these government and technical programs is extremely difficult and it is difficult to find other contractors with a similar expertise. This is mainly due to tight relationships between client and Leidos, data and information requirements, and large costs and time incurred when training a new provider.
  • Cost Advantages: Leidos has access to significant cost advantages stemming from their contracts. Their massive size provides them an upperhand to access cheaper components. Their size also enables them to provide end-to-end solutions, reducing overhead and costs for government agencies.
  • Network Effects: No significant network effects are present here. Their value does not significantly increase as they get more customers. It is more of a bilateral relationship where they directly sell to the client and no networking takes place.

Justification: While the company has some unique features and established operations in a stable industry, they are not strong enough to give it a strong moat. In particular, even though they have some switching costs due to their integrations with large government agencies, those agencies are also very capable of switching contracts if they so desired. The company also has some cost advantages and some reputation, but no major factors that make it better than its competitors in this industry.

Risks to the Moat and Business Resilience

The main risks threatening Leidos’ moat and business resilience include:

  • Government Budget Changes: Fluctuations in government spending can directly impact contract awards and profitability. Political decisions and budgetary constraints can cause reductions or delays in government spending.
 The company mentioned in their latest report that spending in the U.S. government for "on-going programs in security and health," will be limited or delayed. As many of their government contracts are dependent on this it could drastically affect their future financials.
*   **Technological Disruptions:** Rapid technological advancements and innovation could make the company’s current solutions obsolete, requiring significant investments to adapt.
*   **Intense Competition:** While barriers to entry are present, the industry remains intensely competitive. Competitors can also disrupt their business through new or cheaper offerings.
*   **Contract Performance and Execution:** Major projects and acquisitions are highly complex and require meticulous execution. Failure to complete them timely and within budget would lead to losses and diminished returns.
 *   **Dependency on Key Personnel and Talent:** The company depends on highly-skilled employees. Failure to attract or retain that talent would have a negative effect.

    The company also mentioned that "We rely on key personnel and have faced and may continue to face difficulties hiring, training and retaining qualified employees.”
*   **Cybersecurity Threats:** Cybersecurity threats and intellectual property rights can adversely affect both company reputation and financials. The company is particularly vulnerable to these risks given the nature of their work.

    Though they are continually improving their cybersecurity infrastructure, the company can't guarantee complete safety from cyber attacks and this is a very important aspect for them, given their reliance on the federal government, and military.

Leidos has shown great resilience in the past and their strong government relationships, diverse customer portfolio, large-scale operations and a history of revenue and profit generation, positions them to recover from such adversities.

Financials

Leidos has very large revenue, they had over $14 billion revenue over the last fiscal year. They generate revenue through the following business segments.

  • Defense Solutions: This segment is the largest part of the business and accounts for the majority of revenue.
  • National Security: This sector provides cyber security solutions to the US government, that is also a significant source of revenue for Leidos.
  • Civil: This sector focuses on civil government agencies and provides services that enable modernization, infrastructure, data analytics, and technology solutions, which also generates consistent income.
  • Health: Health industry is the most profitable for Leidos and focuses on providing services relating to healthcare to government agencies. They also provide services in clinical research and operations. This sector provides a significant profit portion to the company.
  • Commercial and International: The company has been focusing and expanding into this sector, which is becoming an increasingly large portion of the revenue stream.

The company’s operating profit margin for 2022 was 7.2%, showing their ability to take earnings from the massive amount of revenues they gain. However their net income margins are very small (1.4%) reflecting the interest expenses and non operating expenses. They do have a good ability to generate free cash flow (FCF) as evidenced by strong positive numbers over the past years, mainly due to steady revenue flow and the nature of the business.

In a look at their most recent quarterly report (Sep 2024), the company had strong growth in revenues for the current year, driven by strong demand in their business segments. The company improved their profitability with revenue growing 7.3% and diluted EPS rising to 7.87%. However, the company’s long-term revenue growth is only projected to be 3.5%, which is quite low for a tech company. Management acknowledged their previous quarter had a significant impact in their cash flow from operation and are working to get the timing back on a predictable manner. The company is currently trading at a P/E multiple of around 15, implying the market still regards it as a mature stable business, but not necessarily a high growth company.

Understandability: 4 / 5

Leidos is a large and complex company with various segments, which makes it difficult for a beginner investor to understand it. Also, the structure of their contracts and financial statements can make it complex to figure out how the business operates. However, the core business of a government contractor and a technology and services provider makes it easy to conceptualize what they do, giving a rating of 4/5.

Balance Sheet Health: 4 / 5

Leidos’ balance sheet is reasonably healthy. They have a high debt to equity ratio, currently at around 1.6 (150% debt), due to a large portion of their capital spending being funded by debt. They do have adequate cash and cash equivalents and a solid working capital to continue operations. They do have significant goodwill and intangibles due to their prior acquisitions. Overall their balance sheet strength is rated at 4/5.