Baron Funds, an investment management company, released its “Baron Discovery Fund” third quarter 2022 investor letter. A copy of the same can be downloaded here. Compared to the Russell 2000 Growth Index benchmark, which was slightly positive, the fund (institutional shares) was flat in the third quarter. In addition, please check the fund’s top five holdings to know its best picks in 2022.
In the third-quarter letter, Baron Funds discussed stocks like Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS). Headquartered in San Diego, California, Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) is a government contractor that operates through Kratos Government Solutions and Unmanned Systems segments. On October 28, 2022, Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) stock closed at $11.09 per share. One-month return of Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) was 9.15% and its shares lost 48.15% of their value over the last 52 weeks. Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) has a market capitalization of $1.397 billion.
Baron Funds made the following comment about Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) in its Q3 2022 investor letter:
“Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) shares also declined in the quarter, for reasons similar to those of Mercury Systems, Inc. Like Mercury, we believe Kratos is focused on priority programs within the DoD budget that are starting to accelerate and should lead to substantial revenue growth for Kratos. These programs include missile defense, space-based systems and software, unmanned aircraft (UAVs), advanced rocket engines and aircraft materials (including hypersonic technology), and defense electronics. It is clear that UAVs are going to be a critical component of defense strategies going forward, and Kratos can build these vehicles at extremely low cost but with top-end performance characteristics. The company is a leading supplier of target drones (UAVs that act like enemy missiles or fighter aircraft used for training). Now Kratos has taken that experience and translated it into tactical UAVs that carry missiles, bombs, and sensor equipment. These UAVs have demonstrated they can perform like the most advanced fighter aircraft, but at costs of only $200,000 to $10 million per plane. This is only a fraction of the cost of a new F-35 (about $80 million at volume production) or an F-22, our most advanced aircraft (about $150 million without factoring in development costs). They also cost far less than competitors’ UAVs. These drones operate autonomously, in swarms or as a “loyal wingman” for our most sophisticated fighter jets. We are tracking multiple programs that could become regular defense budget items (programs of record) over the next one to four years. There is currently a lack of viable competitors who can execute on these platforms at Kratos’ price and quality levels. This gives the company a strong first mover advantage.
Until we start to see meaningful tactical UAV revenues, we believe the company’s valuation will be supported by its other programs, in particular its OpenSpace satellite communications software. OpenSpace allows Kratos’ customers to build virtual ground stations that can be easily upgraded and scaled for increased capacity without the significant expense of traditional hardware-based solutions. Additionally, it allows far better interoperability among disparate system types, so they can be combined into one “common operational picture.” Kratos recently won three OpenSpace contracts worth hundreds of millions of dollars combined. Kratos should grow revenues at around 10% to 12% organically for the next several years, and currently trades at about 15 times our 2023 cash flow estimates and 4 times our 2027 estimates. We believe that in a base-case scenario, Kratos shares could double or even triple over the next five years. If we are correct about Kratos’ market positioning, we could see substantial revenue upside on tactical UAVs leading to even larger returns. Moreover, we think that Kratos would be a highly prized takeover candidate, particularly if it wins any of the key tactical UAV programs that are in the works.”
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Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) is not on our list of 30 Most Popular Stocks Among Hedge Funds. As per our database, 20 hedge fund portfolios held Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) at the end of the second quarter which was 17 in the previous quarter.
We discussed Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) in another article and shared the best defense stocks to buy that are too cheap to ignore. In addition, please check out our hedge fund investor letters Q3 2022 page for more investor letters from hedge funds and other leading investors.
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Disclosure: None. This article is originally published at Insider Monkey.
