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July 27, 2009
Share ThisRaytheon (RTN) announced better-than-expected 2nd quarter results. The defense electronics giant -- in contrast to the flagship of defense contractors, Lockheed Martin Corporation (LMT) -- reported 25% higher EPS of $1.24 over the year-ago quarter.
Lockheed Martin reported 13% lower EPS over the year-ago quarter. While Lockheed was swept away by pension blues, Raytheon gained $11 million during the quarter from pension adjustments.
The Details
Raytheon exceeded both our and market expectations of $1.13 for the quarter. Operating income fell marginally year-over-year (1.9%) in the Integrated Defense Systems (IDS) and Missile Systems (MS, 7%) segments. This was more than made up by Network Centric Systems (NCS, 12.6%), Space and Airborne Systems (SAS, 24.1%) and Technical Services (TS, 17.8%), along with steady Intelligence and Information Systems (IIS).
On the revenue front, although Raytheon grew 4% during the quarter to $6.1 billion, it failed to cross our expectations and that of the market of $6.2 billion. Topline growth was fueled by all but the IIS segment, owing to lower volumes in the e-Borders program.
Raytheon suffered a $2.4 billion reversal in its backlog in June 2009 on account of the cancellation of the Kinetic Energy Interceptor (KEI) program. Notwithstanding, the company booked new orders worth $7.6 billion during the quarter and was able to offset most of the impact. Total backlog stood at $37.3 billion at the end of the quarter. The home-run was hit by the IDS, MS, SAS segments; each garnering more than $1 billion in new orders for the company during the quarter.
Raytheon increased its full-year outlook reflecting solid perofrmance during the quarter. The company now expects 2009 revenue in the range of $24.5 - $25 billion, compared to the previous guidance of $24.4 - $24.9 billion. EPS for the year is forecasted between $4.60 and $4.75.
Positive Sentiment
We continue to view Raytheon as one of the best-positioned among the large-cap defense primes due to its non-platform-centric focus, strong order bookings and order backlog, strong cash flow generation and focus on shareholder value. Specifically, revenue and earnings growth are driven by strong demand for missile and missile defense systems and network-centric mission solutions, including sensor and communication systems.
The company also offers investors strong order bookings (notable contracts include the STOC II and FOCUS programs for the U.S. Army, AMRAAM for both international customers and the U.S. Air Force, Standard Missile-3 for the U.S. Navy and the Missile Defense Agency, and Evolved Sea Sparrow Missiles for international customers and the US Navy), an above industry ROE, an improving balance sheet and one of the highest dividend yields in the industry. In the first half of 2009, Raytheon witnessed a brisk pace in its order backlog with total bookings of $12.9 billion and an order backlog of $37.3 billion.
Looking Ahead
Going forward, growth will be driven by focus on ISR unmanned systems, training, cyber security, Standard Missile-3, Patriot, Zumwalt and THAAD. Furthermore, the recent acquisition of Telemus Solutions, a provider of information security, intelligence and technical services, strengthens the company’s focus on the emerging cyber-security market.
However, concerns about the future growth of defense spending on Raytheon programs, given continuing budget deficits as well as concerns related to the company’s program execution, remain ongoing risks.
Over the past year, RTN traded within a range of 6.9x to 12.7x then current-year earnings estimates. Currently, RTN trades at only 9.3x and 8.9x, respectively, our 2009 and 2010 EPS estimates, or at a significant discount to its military electronics industry median and mean multiple values. Likewise, relative sales and cash-flow multiples both indicate a discount valuation of RTN.
The Recommendation
Accordingly, with a predominantly bullish outlook, partially offset by several company-specific risks and an attractive valuation, we note a bias toward outperformance, and maintain our BUY recommendation on RTN stock with a six-month target price of $49.25, or 10.1x and 9.7x, respectively, our 2009 and 2010 EPS estimates. Price appreciation to our near-term valuation target, combined with the stock’s recently increased $0.31 per share quarterly cash dividend -- which we deem sustainable and secure based upon conservative projected payout ratios -- represents annualized total return potential of 20.7%.
Raytheon Company is the one of the largest aerospace and defense companies in the U.S., with a well-diversified line of military products, including missiles, radars, sensors, surveillance and reconnaissance equipment, communication and information systems, naval systems, air traffic control systems and technical services.
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