L-3 Communications (LLL)is a prime contractor in Command, Control, Communications, Intelligence, Surveillance and Reconnaissance (C3ISR) systems, aircraft modernization and maintenance, and government services. L-3 is also a provider of a range of electronic systems used on military and commercial platforms.
Sales, Earnings, Free Cash Flow
|Years||Revenue (in millions)|
Over the past 5 years, revenue growth has averaged 5.8%, though sales are slowing, and in 2010 revenue grew by only 0.42%. As of the second quarter of FY 2011, revenues are lower than last year, and L-3 has issued sales guidance of 15.5 – 15.6 billion – a flat year, with at best only very modest growth.
The lower sales of 2011 can be attributed to lower sales volume overall, as governments cut budgets, but also to the loss of two important contracts, the Special Operations Forces Support Activity contract, and the Afghan Ministry of Defense support contract.
Revenue for L-3, along with every other major defense company, is going to be under the microscope for the next few years, as investors worry about what effect US government austerity will have. Should the budget hawks really tighten the purse strings, there could be significant repercussions – as of 2010, 83% of revenue came from the American government.
Earnings per diluted share have a CAGR of 18.9% over the same 5 year period, showing much stronger growth than sales. This is attributable to increasing margins, lower tax rates, lower interest expense, and decreased shares outstanding. Margins will be examined below, so I’d first like to look at shares outstanding and interest expense.
LLL has gone a great job of using cash flow to buyback shares, and they purchase an average of 2% of outstanding shares per year. So far in 2011, they have repurchased $224 million dollars worth, with plans to continue. LLL has also been taking advantage of lower interest rates, and the company refinanced part of their debt, bringing their interest expense down 34% from last year.
As of the first half of 2011, diluted EPS is up 8% from 2010, from $3.82 to $4.11 (though net income is down by $2 million – share buybacks at work!)
Free cash flow per diluted share has grown by an average of 10.9% in the same 5 year time period, slightly slower than earnings.
Both operating and net margins have been trending upwards in the past few years, from 10.2% to 11.2% (operating) and 4.1% to 6% (net). I always like to see stable, or growing, margins.
Dividends and Stock BuyBacks
L-3 only started paying a dividend in 2004, but they quickly created a culture of yearly increases. The first payment of $0.40 (for the year) quickly grew 25% in 2005, followed by 50% in 2006. Over the past 5 years the average growth has been 20.8%, only slighter faster than eps.
5 year rolling dividend growth has been slowing, but that is to be expected, as maintaining a 31% 5 year growth rate (as it was in 2008) is impossible. Nevertheless, the current rolling 5 year growth rate of 14.3% makes me plenty happy.
Based on the current quarterly payment, I expect a dividend of $1.80 in 2011, a growth of 12.5%.
Payout ratios are low, and leave plenty of room for dividend growth. The earnings based ratio was only 19% in 2010, and the cash based ratio even lower, at 14.4%. Even if the company has stagnant, or slow growing earnings for the next few years, they should still have plenty money left for dividend growth.
L-3 has a moderate balance sheet. The current ratio is 1.9, and debt to total capital is 37.6%. The interest coverage ratio has grown to 6.5 as of 2010, and should go even higher if L-3 continues to refinance debt at even lower rates.
Return on Equity has grown over the years, as it hovers between 10 and 15%. Since I have not yet analyzed any other defense companies, I am not sure how this measures up, but I do see that the ROE is trending up, and stable, which is always a positive.
Stock Price Valuations
current price – $69.06
5 year average low p/e – 12.5
p/e (ttm) – 8.4
p/e (forward) – 8
peg – 1.1
5 year high dividend yield – 1.79%
dividend yield – 2.6%
I find L-3 to be an attractive company at a good price. If I were looking to add a new stock to my portfolio, I think they warrant further consideration.
I would however like to see how their planned spin-off plays out, which will turn the companies government services segment into it’s own publicly traded company. Something to watch.
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Full Disclosure: I do not own any LLL. My Current Portfolio Holdings can be seen here