Here is a rather sober analysis on DynCorp's latest quarterly results. Reasons for concern and "negative" outlook:
- 75% of revenues derive from US operations in Iraq and Afghanistan
- Delays in approving the FY13 defense budget which could hold up orders on current and new contracts
- Further potential cuts to DoD budgets under sequestration
Although contract win rates have increase over the past couple years, operating margins sit at around 5%, suggesting that DynCorp may be cutting costs on its bids to maintain a healthy backlog during tighter times.
This raises a fundamental question about diversification for defense contractors, particularly for those in the Defense & Government Services and Logistics sector. Is it better to be a USG or DoD specialist or to diversify those programs with commercial work? The market has a habit of punishing diversification -- ITT and L3 both spun off businesses that had successfully grown into emerging industrial sectors. The former Chairman of Lockheed Martin once commented that "the record of diversification in the defense industry is unblemished by success." So why is DynCorp getting a negative outlook for specializing?
In a vote for diversification, consider DynCorp's close competitor, KBR. In Q3 KBR had revenue on the LOGCAP contract of just $156M, compared to DynCorp's $438M. Clearly, KBR has been on the losing side of many recent DynCorp advances on market share, and they are fighting to stay relevant in a shrinking, crowded environment for USG logistics & infrastructure services.
However, looking at the bottom lines of both companies, we find operating profits (for 9 months through Sep 2012) of $126M derived from KBR's two Government units (North American Government & Logistics, and International Defense & Support Services), compared to $114M for all of DynCorp for the same period. At KBR the defense business is probably less than 20% of the total, most of which comes from a Hydrocarbons business that produced over half KBR's turnover for Q3.
I think KBR benefits in their Government work by having a diversified portfolio of related commercial work. They’ve protected margins better by making resources compete for returns across many different markets. DynCorp, on the other hand, with its concentration in DoD and State, has to cut its margins and low-bid everything in order to drive revenues/backlog.