Science Applications to correct on high valuation concern

The shares of technology solutions provider Science Applications International Corporation (SAIC) hit a 12-month high of $61.93 on Monday, following the announcement of fiscal 2017 first-quarter earnings and revenue that beat analysts’ estimates.

However, on Tuesday, selling pressure took the stock into negative territory. The shares of Science Applications lost 0.94% to close at $58.01. The company has performed well and there is no denial of that. Still, as explained below, the main reason for the sell-off is the high valuation of the company, relative to its peers.

The Virginia based company reported fiscal 2017 first-quarter revenue of $1.215 billion, compared to $1.01 billion in the corresponding period of fiscal 2016. The revenue estimate of analysts was $1.14 billion.

SAIC

The net income for the first-quarter remained flat at $33 million on a y-o- y basis. The company reported first-quarter earnings of $0.71 per share, compared to $0.69 per share in the prior-year similar period. Excluding costs, the first-quarter earnings were $0.80 per share, compared to $0.73 per share in the year-ago corresponding quarter. The earnings estimate of analysts was $0.76 per share.

The results are definitely impressive. However, the price to earnings ratio of the company is currently 23.6, while that of its peers is 17.3. Similarly, the price to book ratio of Science Applications is 7.2, compared to the industry average of 4.2. In the past five years, the operating margin has declined from 7.9% to 5.3%, which is also a concern. The company also carries a high debt to equity ratio of 2.67. Furthermore, Science Applications was downgraded by Wells Fargo on Monday. It should be noted that the company’s CFO John Robert Hartley sold 23,000 shares of the company at an average price of $51.99. When a top executive of the company sells his personal holding, it is generally perceived as a sign of bearishness. Thus, considering these facts, for the time being, it is better to avoid long positions in the company.

The blue coloured bubble in the chart indicates an exhaustion gap formation. This indicates that the trend has over extended and the price is due for a correction. The RSI indicator is also pointed downwards. Thus, we can expect the price to decline and re-test the 47 levels from where the steep uptrend actually began.

So, it is reasonable to enter into a one touch put option trade in the current situation. The suggested target price for the trade is $50 or higher. Likewise, an expiry period in the second week of July would benefit the trade under the current circumstances.

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