CSRA Completes NES Takeover, Sluggish View Hurts Shares

CSRA Inc. (NYSE:CSRA) recently announced that it has completed the acquisition of Alexandria-based NES Associates for approximately $105 million. This is the company’s first acquisition since it went public in Nov 2015.

At the time of announcement, Lawrence Prior, Chief Executive Officer (CEO) of CSRA stated that “NES has hands-on expertise with nearly every military base network infrastructure, both CONUS and OCONUS and this experience can directly translate to other security-sensitive customers, such as Homeland Security as well as the intelligence community.”

The acquisition will improve the CSRA’s expertise in defense telecom, infrastructure and applications architecture as well as implementation services. We believe that the tuck-in acquisition will help the company to win new contracts going forward.

Moreover, the acquisition is expected to be slightly accretive to fiscal year 2018 results. However, we don’t anticipate it to provide significant impetus to the stock price at least in the near term.

Dim View on New Business Wins Hurts Shares

Despite numerous award wins in first-half 2017, CSRA has underperformed the S&P 500. While the stock returned 0.2%, the index gained 7.8% on a year-to-date basis.

The underperformance can be attributed to the sluggish new business win rate projection – 25% versus 35% – for this fiscal. New business revenue (almost 7% of total revenue) guidance was also lower than the original fiscal 2017 guidance.

In addition to the lacklustre outlook, uncertainty over the renewals of the National Security Administration’s (NSA) Groundbreaker program and the Transportation Security Administration’s (TSA) Information Technology Infrastructure program is a potential headwind.

Moreover, delay in awarding the Greenway program is a concern. We do expect sluggishness in award procurement to continue in the near term (at least over the next two quarters), due to numerous ongoing transitions within the Trump administration.

Balancing Capital Allocation, Partnerships: Key Catalysts

CSRA’s capital allocation plan during the time of its spin-off from Computer Sciences Corp –now known as DXC Technology (NYSE:DXC) – was aimed at 50% debt reduction, 40% shareholder return and 10% to merger & acquisition. However, since the spin off, the company actually spent 79% on reducing debt and 21% on shareholder returns. The company didn’t spend anything on acquisitions till NES.

We note that in the last reported quarter (fourth-quarter fiscal 2017) CSRA spent $20 million to pay off debt and $16 million on dividends. As of Mar 31, 2017, the company had $2.58 billion in debt as compared with $2.78 billion as of Apr 31, 2016.

Management now expects to pursue a more balanced approach in terms of capital allocation. CSRA now expects to use half of its free cash flow to lower debt, which is prudent in our view.

Gartner Places CSRA in Global Top 100 List

Notably, market research firm Gartner recently named CSRA in its annual list of the Global Top 100 IT Vendors in 2016.

The recognition reflects CSRA’s deep domain knowledge and expertise in next-generation IT services, which is aiding it to win new contracts on a regular basis. In first-half 2017, the company won contracts from the likes of Defense Information Systems Agency (DISA), Naval Sea Systems Command (NAVSEA), and the U.S. Air Force.

Further, CSRA’s strong partner eco-system that enables it to offer both Microsoft (NASDAQ:MSFT) Azure and Amazon (NASDAQ:AMZN) Web Services to customers is a key growth driver in the long haul.

Zacks Rank & Key Pick

CSRA currently carries a Zacks Rank #4 (Sell). EPAM Systems (NYSE:EPAM) sporting a Zacks Rank #1 (Strong Buy) is a better-ranked stock worth watching in the same sector. You can see the complete list of today’s Zacks #1 Rank stocks here.

Long-term EPS growth for EPAM is currently pegged at 20%.

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