How reliable is Cold War-era uranium as collateral?
Only nine countries in the world possess the power and influence that comes with an arsenal of nuclear weapons.
As nuclear force is often viewed as the ultimate deterrent against attack by a foreign adversary, these nine governments must constantly invest in advancing their nuclear technology, lest they fall behind at the peril of their own security.
Yet, for one company that provides the U.S. government with nuclear components and technologies, and receives steady contracts in return, credit rating agencies deem its debt high risk, which seems rather illogical given the significant visibility into future cash flows it enjoys.
Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.
Investor Essentials Daily:
Wednesday Credit Insights
Powered by Valens Research
Credit rating agencies have an inherently backward looking view on corporate credit.
One can see this in industries that have transformed themselves, as some parts of the semidocutory space have, to become much more stable businesses with less volatile cyclicality and dependence on swings in demand.
Yet, the major Wall Street credit rating agencies refuse to change. Only when clear headwinds come around for industries they typically dislike, such as independent power firms, do they finally catch up with economic reality.
The bottom line is this: the rating agencies just aren’t particularly reliable.
Even with this understanding, sometimes you see a rating that is in such complete defiance of all logic you can’t help but shake your head, like when Wall Street rates a company essential to the U.S. military as a high yield, speculative credit.
That is the situation we find ourselves in with BWX Technologies (BWXT), a company whose technologies the U.S. nuclear deterrent could not survive without.
Even if we didn’t know anything about the company’s credit profile, just a quick read through a description of its primary business segment (called Nuclear Operations) would highlight it as an unlikely candidate for a high yield rating.
This is because BWX supplies nuclear components, reactors, and assemblies for customers such as the U.S. Department of Energy and the National Nuclear Security Administration, as well as missile launch tubes for U.S. Navy submarines.
Even more interesting, the company converts Cold War-era stockpiles of long-lasting, highly-enriched uranium and develops new technologies for advanced nuclear power sources, a key area of interest for the U.S. government, which keeps the funnel of R&D funding flowing into the companies coffers.
In other words, this is a business that has incredibly high visibility into future cash flows and is unlikely to find itself in a difficult credit position.
Despite this, Moody’s rates BWX as a non-investment grade Ba2 credit, implying a 10%+ risk of default over the next five years.
Here at Valens, however, we look at credit a bit differently.
Our Credit Cash Flow Prime (CCFP) analysis is able to get to the heart of the firm’s true credit risk.
In the chart below, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand available at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).
As depicted, BWX’s cash flows alone will exceed all obligations every year over the next 5 years, which suggests plenty of comfort for investors. Moreover, the company’s lack of any substantial maturing debt until 2026 and healthy levels of cash on hand make the rating agencies pessimism even more illogical.
Rather than a distressed credit, BWX is actually in a quite comfortable cash position. This is why Moody’s speculative Ba2 rating does not make much sense.
Using the CCFP analysis, Valens rates the company as an investment grade IG4+. This rating corresponds with an expected default rate below 2% within the next five years, a more realistic projection once a holistic understanding of the company’s risk is taken into account.
Ultimately, Uniform Accounting and the Credit Cash Flow Prime analysis highlight how BWX’s credit risk profile is much safer than what rating agencies believe, especially when considering the company’s stable cash flows thanks to its government contracts.
If credit rating agencies can’t even get this one right, you can only imagine what else they’re getting wrong…
SUMMARY and BWX Technologies, Inc. Tearsheet
As the Uniform Accounting tearsheet for BWX Technologies, Inc. (BWXT:USA) highlights, the Uniform P/E trades at 24.7x, which is around the global corporate average of 24.3x, but below its historical average of 28.5x.
High P/Es require high EPS growth to sustain them. In the case of BWX, the company has recently shown a 1% Uniform EPS growth.
Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, BWX’s Wall Street analyst-driven forecast is an EPS growth of 33% and 19% in 2021 and 2022, respectively.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify BWX’s $55.57 stock price. These are often referred to as market embedded expectations.
The company is currently being valued as if Uniform earnings were to grow 11% annually over the next three years. What Wall Street analysts expect for BWX’s earnings growth is below what the current stock market valuation requires in 2021 and 2022.
Furthermore, the company’s earning power is 2x the corporate average. Also, cash flows and cash on hand are 2x above its total obligations—including debt maturities, and capex maintenance. This signals a low dividend risk.
To conclude, BWX’s Uniform earnings growth is above its peer averages and trading below its average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research