Government IT investors have been on edge since the U.S. election and the subsequent announcement of the waste-cutting initiative that Donald Trump calls the Department of Government Efficiency (DOGE)
This earnings season provides sector leaders a platform to comment on the potential impact, and an initial attempt to do so appears not to have provided much comfort.
Shares of CACI International (CACI -9.35%) traded down as much as 10% on Thursday morning following the company’s earnings release, and were down 5% as of 11 a.m. ET. Shares of rivals Leidos Holdings (LDOS -7.57%) fell as much as 8%, and Booz Allen Hamilton (BAH -4.80%) and Science Applications International (SAIC -7.67%) fell as much as 7% apiece, as investors pondered what the future holds for this sector.
An uncertain future
CACI, Leidos, SAIC, and Booz Allen are four of the largest so-called “Beltway Bandits,” or companies that run IT networks and provide other services to military and civilian government agencies. Investors aren’t certain whether the new administration’s talk of streamlining government will be a positive or negative to the sector: It could mean more outsourcing opportunities, or it could mean a slowdown in contract spending.
CACI beat top- and bottom-line estimates in its fiscal second quarter ending Dec. 31, but the focus was more on what is to come. The company made its case that its strategy is “purpose-built” for DOGE, noting that CACI already has several contracts to implement software to modernize government agencies and make them more efficient.
“We don’t need to ask to be included in this transformation; we are already leading it,” the company said in its presentation to investors.
But the post-earnings call spooked investors instead of reassuring them, sending shares of CACI down sharply and leading Leidos, SAIC, and Booz Allen shares down in sympathy. The most likely culprit was talk of changing the way the government awards contracts.
Currently, a significant portion of defense IT work is arranged as “cost-plus” contracts, meaning the contractor has assurances they will receive full reimbursement for their expenses, plus some amount of profit margin. There has been talk of DOGE shifting awards to fixed-price, where the contractor has more responsibility for any cost overruns that might zap profitability.
CACI management seemed to acknowledge such a shift was possible. CEO John Mengucci argued that in areas where CACI has operated in the past, the company is well positioned to know its costs beforehand and can still generate strong profits in a fixed-price world.
Are defense IT stocks buys right now?
Lost in some of the speculation was the fact that CACI produced a strong quarterly beat and raised its full fiscal-year earnings and revenue expectations. The company ended the period with a backlog of $31.8 billion in future business, up 18% from $26.9 billion a year ago.
The concerns are understandable, and defense IT investors should expect continued volatility from here as the market deals with the uncertainties created by the transition in Washington. But as CACI shows, the industry has a strong backlog of future business, as well as the opportunity to play a significant role in whatever transformation occurs.
For those interested in defense stocks and have the patience to ride out near-term volatility, these dips could be buying opportunities.
Lou Whiteman has positions in Booz Allen Hamilton and Leidos. The Motley Fool recommends Booz Allen Hamilton. The Motley Fool has a disclosure policy.
