Why Kratos Defense stock is up 5.5% today

Kratos Defense and Security Solutions (KTOS 4.37%) The stock enjoyed a second straight day of gains on Wednesday, as the stock was up 5.5% by 2:55 PM ET — significantly better than yesterday’s 1.2% gain.

And yet yesterday’s news drove the gains.

Kratos gets a defense contract

Specifically, news that the US Air Force has awarded Kratos a $79.9 million contract to produce 60 BQM-167A “target aircraft systems” (ie, target drones). The additional $80 million represents about 7 percent of annual revenue for the defense contractor.

And yet, it was not unexpected. As Kratos mentioned, this order is for the 20th “batch” of drones to be delivered under a five-year supply contract worth up to $374 million in total for the company. The company expects a total of about 21 lots to be ordered to maximize that value, so the contract is nearing completion — both good and bad news for Kratos. (Although the contract can certainly be extended or renewed.)

Is Kratos stock a buy?

In short, I don’t expect this contract — despite its size — to move the needle much for Kratos stock in terms of changing upside expectations. And that could be a problem for investors, because Kratos is one very expensive defense stock.

Last 12-month earnings for Kratos come in at just $10 million, which isn’t much to support a $3.4. billion stock market capitalization. And free cash flow at the defense contractor is even worse — just $2.6 million. As a result, the stock is selling for a price-to-earnings-growth (PEG) ratio of about 340, and the price-to-free cash flow ratio stretches well into the four figures.

Strong earnings growth, of course it is forecast, analysts expect profits to roughly triple over the next two years. Analysts had better be right about that, though, because at prices like these, nothing short of fantastic growth can justify the sky-high valuation of Kratos stock.