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Kratos Defense: A Small-Cap Play On Shifting Defense Policy

Summary

Kratos is a small-cap defense and aerospace company whose products are coming into vogue as the US Government shifts their focus from ground combat to anti-access strategy.

Their fiscal year second quarter results were encouraging and shares were bid up from the mid $4 range to a high 52 week high of $6.87.

Despite their high debt levels there are two weapons programs in particular that I believe will drive Kratos higher and finally allow the company to service that debt.

Kratos Defense and Security (NASDAQ:KTOS) is a small-cap defense company that has been operating in several niche defense markets that are quickly becoming less niche and more mainstream.

Kratos' Laser Weapons System aboard USS Ponce (Source: US Navy)

During the kinetic engagements in Iraq and Afghanistan over the last 15 years the Department of Defense had been focused on outfitting their ground forces for combat operations. The unconventional nature of our enemies we encountered on the ground led to a rapid shift in defense spending. What may be seen as "pet projects" like missile defense, laser technology, and more advanced missiles and drones were placed on the back burner. Taking their place were more necessary projects like the MRAP, MAT-V, more capable body armor, the MV-22 Osprey and other weapons and programs that were useful against our enemies. It makes sense, developing lasers to mount on giant ships isn't very vital when you're fighting in a landlocked country against an enemy who doesn't even have aircraft as was the case in Afghanistan. Now that the wars are all but over we are seeing a shift back into aircraft, missiles, drones and lasers as a response to our Chinese and Russian adversaries. I believe companies like Kratos stand to profit.

The company has seen a recent surge in share price thanks to their encouraging second quarter results. The conference call boosted investor confidence as well thanks to the CEO, Eric DeMarco, stating that the company expects to finally receive government funding for their UTAP-22 drone. This drone has been a main focus of Kratos and it has been a drain on the finances since they have self-funded the entire program. Should the drone succeed it would be a huge market for the company.

Even with the quarterly results easing some worries there are concerns as far as financials are concerned. The company is...


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