I find Raytheon Co. (NYSE:RTN) stock to be a good combination of value and dividend growth stock. Although the stock price has risen 69.5% since the beginning of 2013, it is still an excellent buy right now. This is compared to the 30.0% rise of the S&P 500 index and the 43.0% rise of the Nasdaq Composite Index during the same period. In this article, I will explain why, in my opinion, Raytheon stock is a remarkably promising long term investment.
Raytheon is the world's fifth largest military contractor and a leading maker of missiles and radar. The company is specializing in defense and other government markets throughout the world. Raytheon was founded in 1922 and is based in Waltham, Massachusetts.
On February 24, the Pentagon said it would shrink the U.S. Army to pre-World War Two levels, and reduce military benefits in order to meet 2015 spending caps, setting up an election-year fight with the Congress over national defense priorities. Defense Secretary Chuck Hagel, previewing the Pentagon's ideas on how to adapt to government belt-tightening, said the defense budget due out next week would be the first to look beyond 13 years of conflict, shifting away from the long-term ground wars like Iraq and Afghanistan.
Seventy two percent of Raytheon's revenues came from the U.S. military in 2013 (73% in 2012 and 74% in 2011), though international orders have been an area of strength in recent periods, and are expected to represent about 30% of 2014 sales.
Raytheon operates in four reportable segments: Integrated Defense Systems, Intelligence, Information and Services, Missile Systems and Space and Airborne Systems.
A comparison between the different segment's revenue in 2013 to that of 2012 is shown in the chart below.
Source: company's reports
The Space and Airborne Systems segment showed the highest sales decline in 2013, sales were $6,371 million, a 6.6% decrease from $6,823 million in 2012. Operating margin was at 14.4% in 2013 and 14.5% in 2012. Operating margin improved in the fourth quarter of 2013 to 15.7% this compared to 15.5% in the fourth quarter of 2012.
The Integrated Defense Systems segment showed the highest operating margin growth in 2013 to 17.2% from 16.1% in 2012. Sales were almost the same $6,489 in 2013 and 6,492 in 2012.
The table below presents the valuation metrics of RTN, the data were taken from Yahoo Finance and finviz.com.
Raytheon's valuation metrics are very good; the company has a relatively low debt, the enterprise value-to-revenue ratio is quite low at 1.30 and the enterprise value-to-EBITDA ratio is low at 9.24. According to Yahoo Finance, RTN's next financial year forward P/E is very low at 12.53, and the average annual earnings growth estimates for the next 5 years is quite high at 12.35%. These give a very low PEG ratio, for a large cap company, of 1.01. The PEG Ratio, the price/earnings to growth ratio, is a widely used indicator of a stock's potential value. It is favored by many investors over the P/E ratio, because it also accounts for growth. A lower PEG means that the stock is more undervalued.
Latest Quarter Results
On January 30, Raytheon reported its fourth-quarter and full-year 2013 financial results, which beat EPS expectations by $0.11 (8.10%).
- Fourth quarter 2013 net sales of $5.9 billion; full-year net sales of $23.7 billion, down 2.9 percent for the year
- Fourth quarter Adjusted Operating Margin1 of 13.1 percent; full-year Adjusted Operating Margin1 of 13.4 percent, up 10 basis points for the year
- Fourth quarter reported operating margin of 12.1 percent; full-year reported operating margin of 12.4 percent, up 20 basis points for the year
- Fourth quarter Adjusted EPS1 of $1.58; full-year Adjusted EPS1 of $6.38, up 1.6 percent for the year
- Fourth quarter EPS from continuing operations of $1.46; full-year EPS from continuing operations of $5.96, up 5.5 percent for the year
- Strong operating cash flow from continuing operations of $1.1 billion in the quarter and $2.4 billion for the year
In the report, William H. Swanson, Raytheon's Chairman and CEO said:
Over the past year, the Raytheon team delivered solid operating results in a dynamic business environment. We continued to expand our international business while also winning significant new programs with our advanced technologies and affordable solutions that position us well for the future.
The company also said it expected sales and earnings per share to drop further in 2014, given a decline in U.S. military spending, but said operating margins would remain strong.
The company had $33.7 billion in backlog at the end of 2013, this compared to $36.2 billion at the end of 2012. Booking for the fourth-quarter was $7.5 billion that gives a book-to-bill ratio of 1.28.
Dividend and buy-back program
Raytheon has been raising its dividend payment since 2002. The forward annual dividend yield is at 2.25%, and the payout ratio is only 36%. The annual rate of dividend growth over the past three years was quite high at 13.66%, and over the past five years, was also high at 14.46%. I consider that besides dividend yield, the consistency and the rate of raising dividend payments are the most crucial factors for dividend-seeking investors, and RTN's performance has been impressive in this respect.
Raytheon's dividend is paid every quarter, as shown in the charts below.
In the fourth quarter of 2013, the company repurchased 4.7 million shares of common stock for $400 million as part of its previously announced share repurchase program. For the full-year 2013, the company has repurchased 15.2 million shares of common stock for approximately $1.1 billion. Also, as previously announced in November 2013, the company's board of directors authorized the repurchase of up to an additional $2.0 billion of the company's outstanding common stock.
Competitors and Group Comparison
A comparison of key fundamental data between Raytheon and its main competitors is shown in the table below.
Source: Yahoo Finance
Raytheon's valuation metrics look better than those of its main competitors. Raytheon has the strongest earnings growth prospects, one of the lowest forward P/E ratio, and by far the lowest PEG ratio among the group.
Raytheon's return on capital parameters have been much better than its industry median, its sector median and the S&P 500 median, as shown in the tables below.
Personally I am using only fundamental analysis for my investment decisions. After many years of experience, and after having tried all kinds of decision-making including technical analysis, I have reached the conclusion that relying on fundamental information is giving me the highest return. Nevertheless, some investors are successfully using technical analysis to find the proper moment to start an investment (I am not talking about traders; my analysis is only for investors). The charts below give some technical analysis information.
The RTN stock price is 3.29% above its 20-day simple moving average, 6.64% above its 50-day simple moving average and 23.58% above its 200-day simple moving average. That indicates a strong short-term, mid-term and long-term uptrend.
Chart: TradeStation Group, Inc.
The weekly MACD histogram, a particularly valuable indicator by technicians, is at 0.27 and ascending, which is bullish (a rising MACD histogram and crossing the zero line from below is considered an extremely bullish signal). The RSI oscillator is at 74.81 which indicate overbought conditions.
Analyst opinion is divided among the twenty one analysts covering the stock; four rate it as a strong buy, five rate it as a buy and twelve rate it as a hold.
Although the U.S. government decision to reduce the nation's defense budget might be harmful for Raytheon, since about 70% of its revenues still come from the U.S. military, the company still has a massive backlog of $33.7 billion, booking for the fourth-quarter was at $7.5 billion, and that gives a book-to-bill ratio of 1.28. Considering the strong earnings growth prospects of the company, its massive backlog and the last quarter book-to-bill, it seems that the market has not yet discounted this information, and the stock is still cheap. Furthermore, by decreasing the U.S. army to pre-World War Two levels, shifting away from the long-term ground wars like Iraq and Afghanistan, the U.S. army will need to rely more on long distance capabilities, and this will benefit Raytheon, which produces the most sophisticated missile systems and space and airborne systems.
Raytheon is expected to show strong earnings growth. Although according to Raytheon management's revised guidance, its estimate net sales for 2014 of $22.5-$23.0 billion are lower than the actual $23.7 billion net sales in 2013, the company is expecting an increase in its EPS from continuing operations of about 15% from $5.96 to $6.74-$6.89.
The company depends on the U.S. Government for a substantial portion of its business, and changes in government defense spending and priorities could have consequences on its financial position, results of operations and business. Raytheon's international business is subject to geopolitical and economic factors, regulatory requirements and other risks. According to Raytheon, it enters into fixed-price and other contracts which could subject it to losses in the event that it face cost growth that cannot be billed to customers.
Raytheon has compelling valuation metrics and strong earnings growth prospects; its PEG ratio is only 1.01. Furthermore, according to Portfolio123, its two years Sharpe ratio, which measures the ratio of reward to risk, is exceptionally high at 2.520, much better than the industry median of 1.078 and S&P 500 median of 0.993.
Raytheon is generating strong free cash flows and returns value to its shareholders by stock buyback and by increasing dividend payments. For the full-year 2013, the company has repurchased 15.2 million shares of common stock for approximately $1.1 billion. Also, as previously announced in November 2013, the company's board of directors authorized the repurchase of up to an additional $2.0 billion of the company's outstanding common stock.
All these factors lead me to the conclusion that RTN stock still has room to go up. Furthermore, the rich dividend represents a gratifying income.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in RTN over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.