VSE Corporation: Beginning to Take-Off

About two months ago, I took an initial look at VSE Corporation (VSEC), a micro-cap company which provides engineering and support services to the Department of Defense and various other agencies of the federal government. At the time, the stock was just about as hidden as it could be with a float of only 1.4 M shares and an average daily trading volume of just under 7,500 shares. In fact, there were a couple of trading days around that time when the number of shares traded was zero. The company sported some very strong fundamentals with net income growing at an annualized rate of 57% per year over the last three years.

On April 27, the company reported results for the first quarter of 2007 which showed continued impressive growth in revenue, net income, and earnings per share. At the same time, funded backlog increased 47%, thus pointing the way to strong future revenue growth. The initial market reaction drove the stock price up 8% to 49.52 on high volume. Since then, the price has continued to rise on very heavy volume with many days seeing volume in excess of 20,000 shares. As of Monday’s close, the stock stands at 69.10 having risen 51% from the pre-earnings price.

A company this small does not generate much news, but there have been a few items of note since the beginning of May. On May 1, the company declared a 2-for-1 stock split which will result in 4.9M shares outstanding and which should help create a bit more trading liquidity. On May 10, BearingPoint, a management and technology consulting firm, announced that it had won a five-year contract worth up to 99M to help improve management at the Air Force. BearingPoint will be leading a team which includes a number of small companies among which is VSE Corporation. On June 4 it was announced that VSE had acquired Integrated Concepts and Research Corporation, a company which provides diversified technical and management services to the federal government. VSE paid 11.6M in cash for ICRC and may make additional payments up to 5.8M if certain financial targets are met over the next six years. During its most recently concluded fiscal year, ICRC had revenues of 59M and net income of 1.5M.

In early May, I ran a valuation of VSEC. This is now woefully out of date given that the stock has appreciated 26% in the last month. Here are some updated considerations which will give us an idea of the current valuation. I have tried to incorporate the effect of the ICRC acquisition into these figures.

Market cap: 168M
Share price: 69.10
Enterprise value: 170.2M
TTM revenue: 480.1M
EV/revenue: .35
TTM owner earnings: 10M
EV/OE: 17

Given that the company has been growing earnings at an annualized rate of 57%, the EV/OE multiple of 17 suggests that the current price is still attractive. Indeed, if we assume a 20% growth rate over the next several years, we still have (EV/OE)/G coming in at less than 1, namely at .85. An alternative to trying to forecast a future growth rate is to reverse engineer a DCF calculation to see what growth assumption is built into the current price. This calculation shows that the current price represents fair value under the assumption of 10% growth over the next 5 years, 3% terminal growth, and an 11% discount rate. Since there is good reason to believe that the company will achieve much better than 10% growth, the current price continues to look quite attractive.

Disclosure: Author has a long position in VSEC

VSEC 1-yr chart