L-3 Communications: Playing Defense

| About: L-3 Communications (LLL)

The recession weighed on the global economy and weakened many firms. But robust spending by the US government has bolstered companies such as defense contractor L-3 Communications (NYSE: LLL).

New York-based L-3 is a key player in the defense industry. It operates in four main business segments: electronic systems; government services; aircraft modernization and maintenance (AM&M); and command, control, communications and intelligence, surveillance, and reconnaissance (C3ISR).

Although numbers for the first half of 2009 lagged historical trends, the company regained momentum in the second half of the year. L-3 reported strong fourth-quarter results that topped Wall Street expectations as net sales climbed 5 percent to $4.2 billion (see conference call transcript here). Annual sales hit a record $15.6 billion.

Fourth-quarter net income fell because of increased pension and tax expenses, which offset rising revenue. Despite economic conditions, L-3 generated solid operating numbers and cash flow. Management revised upward its profit and revenue guidance for 2010.

Much of the firm’s revenue growth is fueled by its intelligence, surveillance and reconnaissance (ISR) business; strength here has offset weakness in other businesses such as the government services segment. ISR is projected to keep growing; the fiscal year 2011 defense budget of $708.2 billion--up 7.2 percent from the fiscal year 2010 budget--will only add to the momentum.

Pressure is mounting on the federal government to rein in spending, but defense is one area that has become immune to politics in recent years. Every congressional district, it seems, has some piece of a defense contract. And the US is waging two wars, three if you count the war on terror.

This continuation of Bush-era policies bodes well for L-3; its already solid foundation will support long-term revenue growth. The company already supplies ISR equipment to the military; the Obama administration’s plan to send 30,000 additional troops into Afghanistan provides an opportunity for L-3 to outfit the troops with additional ISR products.

L-3 continues to innovate, too. Within its AM&M segment, the firm launched Mobius, a company-developed aircraft that can be flown either by an on-board pilot or via remote control. The growth potential for this aircraft is huge, representing perhaps billions of dollars in new sales.

L-3 boasts a strong balance sheet, with a low debt-to-capitalization ratio and $1 billion in cash. The company has long-term debt of $4.1 million but is making strides to pay that down. At the end of the third quarter 2009 the company offered $1 billion in bonds, using the proceeds to address these debt concerns. Since its initial recommendation in May 2009, the stock has returned 14.2 percent.

The stock trades at 9.8 times 2011 earnings and recently increased its quarterly dividend.

Disclosure: No positions