L-3 Communications Holdings: Long Term Value With a Margin of Safety

| About: L-3 Communications (LLL)

I believe L-3 Communications (NYSE:LLL), at approximately $79/share, offers long term value with a margin of safety on a cash flow valuation basis.

L-3 Communications is a leading provider of high-technology products, systems, and subsystems in the defense electronics business. The company sells products to the U.S. Department of Defense (76% of 2009 sales) as well as other U.S. and foreign governmental agencies and commercial customers. Areas of focus include intelligence, aircraft modernization, simulation and training, communication systems, and specialized products such as bomb-detection equipment.
(Source: Morningstar.com)

I estimated the firm's WACC [weighted average cost of capital] at 9.25% using the Capital Asset Pricing Model and the company's recent SEC filings. ValuePro has a baseline WACC calculator here and it calculates the firm's WACC at 6.74%. Go with the higher mark, 9.25%.

LLL's recent free cash flows and noted growth rates:

Year FCF $Millions
2000 80
2001 125
2002 256
2003 373
2004 540
2005 727
2006 918
2007 1113
2008 1169
2009 1221
TTM 1257
  • Average Annual Growth is approximately 38%

  • CAGR: Approximately 35%

  • Internal Growth Rate: Approximately 5%

  • Sustainable Growth Rate: Approximately 13%

  • Consensus Forecast Industry 5-Year Growth: Approximately 17% per year

  • Consensus Forecast Company 5-Year Growth: Approximately 8% per year

Assuming the company achieves a lower 5-year growth rate of 3% per year, and assuming that after the next five years, the company achieves no growth or 0% growth per year forever.

Discounted Cash Flow Valuation:

Year FCF $ Millions
0 1257
1 1295
2 1334
3 1374
4 1415
5 1457
Terminal Value 16131

The firm's future cash flows, discounted at a WACC of 9.25%, give a present value for the entire firm (Debt + Equity) of $15,711 million. If the firm's fair value of debt is estimated at $4,307 million, then the fair value of the firm's equity could be $11,404 million.

$11,404 million / 113 million outstanding shares is approximately $101 per share. A 20% margin of safety from here is approximately $81 per share and LLL's current share price is approximately $79. I believe LLL currently offers long term value with a margin of safety on a cash flow valuation basis.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.