Can Orbital Sciences Be More Than Just A Good Idea?

By Vinayak on Friday, September 20, 2013 with 0 comments

If you want to be uncharitable, you could say that Orbital Sciences (ORB) is a company with a great future in its past. Going beyond the "gee whiz" factor of a company that builds launch vehicles and space systems, this is a company that has shown generally solid progress in revenue growth over the years but has struggled to show consistent free cash flow production or stock price appreciation.
Orbital could be looking at a period where results turn up, though. The commercial satellite business should benefit from a cyclical upswing in orders, and the company's participation in NASA programs tied to the International Space Station (ISS) should begin to pay off in the coming five years. Underlying that is a relatively stable business built around missile defense and military and research satellites. There will always be risks tied to government budgeting priorities and spectacular operating failures, but I can sympathize with investors taking a "it's different this time" approach to Orbital Sciences.
Commercial Space Finally Getting Its Chance?
With the retirement of the Space Transportation System program (aka "Space Shuttle"), NASA has pretty much put it eggs in the basket of commercial launch vehicles and services. This is not an entirely unfamiliar approach for NASA; while the United Launch Alliance between Boeing (BA) and Lockheed Martin (LMT) is relatively new, the companies go a long way back with NASA through their Delta and Atlas programs.
NASA is supporting additional options, though, and Orbital Sciences has a good chance of participating on a long-term basis. Orbital Sciences has launched more than 70 launch vehicles since 1990, with solid success rates for the Pegasus and Minotaur programs (and not-so-solid for the Taurus). In fact, just last week an Orbital Sciences Minotaur V successfully launched NASA's Lunar Atmosphere and Dust Environment Explorer (LADEE) on its way..
More to the point for the future, the company has been developing Antares, a medium-class rocket that can launch up to 14,000 pounds into orbit at potentially half the cost of a launch from the high-end Delta/Atlas alternatives. The Antares has been developed as part of the company's participation in the Commercial Orbital Transportation Services (COTS) and Commercial Resupply Services (CRS) programs - programs designed to foster and support commercial launch alternatives to send supplies and crew to the ISS. For Orbital's part, they will be developing the Antares rocket and Cygnus capsule to participate in eight missions worth close to $2 billion, with the possibility of additional awards down the line.
Orbital is not alone here, though. SpaceX, the private space transport company founded by PayPal/Tesla founder Elon Musk, has also won COTS and CRS contracts for its Falcon 9 vehicle and Dragon capsule. It's also well worth noting that SpaceX has lofty ambitions, including a "Falcon Heavy" launch system that would rival the old Saturn V and advanced manned vehicles. Should SpaceX do a better job of hitting its development and demonstration milestones, and/or perform better in service, there's no reason to think that NASA wouldn't shift more of those potential future orders to SpaceX.
Missile Defense And Satellites Pay The Bills
While there's admittedly more space-geek appeal to the Antares and Cygnus programs, that's really only a part of what Orbital Sciences is about. The company's operations in missile defense and satellites are another significant source of year-to-year revenue and cash flow.
Orbital is a major supplier of missile defense interceptor and target components. Orbital is the sole supplier of boost vehicles to Boeing for the U.S. Ground-based Midcourse Defense program (GMD), a seven-year, $3.5 billion deal that started in December of 2011. Orbital also provides ballistic missile targets and the Coyote supersonic sea-skimming target vehicle that is designed to simulate cruise missiles like the Russian Sunburn (SS-N-22) and Krypton (Kh-31) and the Russo-Indian Brahmos (PJ-10). Although Orbital does face rivals like Lockheed, Raytheon (RTN), L-3 (LLL), and Alliant Techsystems (ATK), Orbital has built a solid reputation here and enjoys roughly 50% share in the market.
Orbital doesn't only launch satellites, the company also builds them. Orbital has developed numerous satellites for the Department of Defense, national intelligence agencies, and NASA for a variety of defense/intelligence and science/research purposes.
Orbital is also a player in the market for small and mid-sized communications satellites, including its GEOStar platforms. Communication satellite orders have tended to go in seven to eight-year cycles, with the last peak in orders having been in 2008/2009. While the cycle will probably start to lengthen as the functional lives of satellites improve (more than 60% of the order base is replacement business), I nevertheless believe that Orbital will see increasing orders (along with revenue and profits) over the next three to five years. Here again, though, this is a competitive business and rivals like Lockheed, Boeing, and Loral (LORL) can often offer a wider range of services and designs.
Budget Cycles And Revenue Recognition Could Impact Growth
I believe that Orbital is looking at several years of improving demand for its vehicles, services, and satellites. Importantly, Orbital Sciences has long pursued a disciplined bidding strategy, only going for programs where the company believes it has a strong chance of success (both in winning the bid and carrying out the contract profitably). It does not automatically follow, though, that this will translate directly into strong revenue, margins, or cash flow.
For starters, Orbital has long relied on various parts of the U.S. government for a large percentage of its revenue (over 70% in each of the last three years). Various defense programs could be canceled, reduced or altered, and further issues with the federal budget could likewise impact funding. So too for NASA and its research and launch budgets, and the possible decommissioning of the ISS in 2020 is definitely a risk to future expansion of the CRS program and follow-on orders.
Revenue recognition is also an issue to consider. Orbital has already booked $1.1 billion of its $1.9 billion CRS contract into revenue, and the actual per-launch collectible amounts will be relatively small (about 25%). What that means is that a lot of Orbital's future is already being booked in the present, and if there are serious setbacks with the program there would likely be some punishing reversals.
Orbital's large balance of unbilled receivables (over $500 million) should translate into strong reported free cash flow at a later date. That said, the NASA's Office of the Inspector General issued a report in June of 2013 arguing that the agency had been paying Orbital too far ahead of schedule and should slow its payments to the company, despite acknowledging the progress of the Antares program.
It's also important to note that Orbital lacks control over a key component that is essential to its future growth plans - engines for the new Antares rocket. The company has about 20 engines under contract with Aerojet Rocketdyne (engines which were produced by Russia's Kuznetsov), but future access could be problematic. The company has filed suit against United Launch Alliance for refusing access to the RD-180 engine, but there is no certainty to the outcome here. It's worth noting that SpaceX develops its own engines.
All of that said, I still believe that Orbital will see an upswing in revenue and cash flow over the next five or so years. Long-term, I expect to see a revenue growth rate of about 6%, but I believe double-digit growth rates are possible over the next five years. Likewise, I expect the company to report an improvement in free cash flow margins over the next five years, possibly reaching double-digits, before declining to a steady-state that I believe will be in the mid-single digits.
The Bottom Line
Investors should note that this is only a summary of the investment prospects for Orbital; I don't pretend to have covered every topic and by no means is it a substitute for full due diligence. That said, I do believe that are reasons for investors to believe that Orbital will start delivering on some of its potential over the next five years. That said, with the stock up only 8% over the past 21 years (and down 28% over the past five), it's certainly worth pointing out that Orbital has been around for quite a while without really going anywhere from a long-term stock perspective.
My aforementioned cash flow estimates suggest a fair value in the low $20's today ($22), and that is enough to keep these shares on my watch list. Additional successful Antares launches should help the stock move forward, as well as improvements in the margins tied to the CRS program. Still, this is a company with above-average risks, including the possibility of rather spectacular launch failures splashing across the news.

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