Mercury Systems (MRCY) is a provider of secure processing subsystems in RF markets for defense and intelligence applications.  It operates in two segments, MCE, which designs embedded processing modules and subsystems, and MDS, which designs sensor processing subsystems for surveillance, reconnaissance, and electronic warfare.  MRCY is one of the only pure play defense electronics companies and is aligned well with growth drivers in the defense industry.  With global uncertainty heightened between a resurgent Russia, Chinese militarization, ISIS threat, North Korea agitation and Middle East instability, MRCY’s products will continue to see strong demand. 

The $1.02B company trades 38.3X Earnings, 4.09X Sales, 2.32X Book and 37.57X FCF with no debt and a healthy cash holding.  MRCY struggled to grow revenues through 2014, but posted 12.5% growth in 2015, and projects 7.5% this year, followed by a 41% jump next year, and 10% the year after.  MRCY turned a profit in 2015 and is projecting 5.7% EPS growth this year, and 40% annual growth 2017 and 2018.  MRCY has been active with M&A to expand its total addressable market including a recent deal for 3 defense-oriented businesses from Microsemi (MSCC) that is strongly accretive and done at an attractive price.  MRCY is also a margin expansion story with its M&A strategy boosting that effort, EBITDA margins of 13.7% in 2015 are set to hit 20.5% in 2016 and rise to above 24% by 2018.  MRCY posted a record for backlog and revenue coverage ratio in 2015.  MRCY will report earnings August 2 after the close and shares have closed higher on earnings 6 of its last 7 reports with an average 6 quarter max move of 10%. 

On a seasonal basis, MRCY demonstrates strength in Q4 with a 10 year average return of +15.84%, extremely strong compared to other quarters/months. 

On the chart MRCY shares have made a strong run since clearing $22 resistance, but really lack much price resistance until the $32 level.  

In closing, although MRCY shares have returned nearly 40% YTD already, it has the makings of a name that can continue higher.  It is accelerating EPS, Revenues and Margins, even though much of it is through M&A, and has flexibility to do further M&A.  It is a niche play in what is an industry with stable and long-term demand, and could itself become an attractive target.  I can see MRCY earnings well over $1 by FY18, and deserving of a premium multiple, so shares still appear around 35% undervalued at current levels.