Shares of Kratos Defense & Security Solutions (NASDAQ:KTOS) fell 10% on Thursday following a Wall Street downgrade. The defense hardware supplier stock has had a good run over the past year, and one analyst feels the price is getting ahead of fundamentals.
Kratos, a maker of drones, defense electronics, and other products for the Pentagon and other government buyers, has seen its shares gain more than 50% in the last year heading into Thursday trading, and up more than 800% over the past five years.
Investors are excited about its products including next-generation drones designed to fly alongside crewed fighter pilots. Kratos’ Valkyrie drone has been on trial with the Air Force for more than a year now, leading to speculation that an order could be forthcoming.
Kratos is also widely speculated as a potential inclusion in the space-focused exchange-traded fund planned by Ark Invest.
Baird analyst Peter Arment on Thursday threw some cold water on that excitement, downgrading Kratos to neutral from outperform and keeping his $29 price target. Arment said he remains positive about Kratos’ outlook, but believes valuation is stretched.
Kratos has for years been the rare moon-shot company in the otherwise staid defense sector, with intriguing potential but also a lot more volatility than most defense companies. As the company has matured the volatility has eased somewhat, but this is still a stock that has captured investor imagination, and which trades as much on its potential as on its current business.
Even after Thursday’s decline the stock trades at 4.7 times sales, more than double the multiple assigned to larger defense contractors including Lockheed Martin, Northrop Grumman, and L3 Harris Technologies.
There’s still a lot to like about Kratos, but as Arment notes it might take some time for that potential to translate into actual sales. We’ll learn more on Feb. 25, when Kratos is expected to announce fourth-quarter results, but after a strong run up it is fair to question how much more momentum Kratos shares will have to climb higher in the months to come.
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