Straddling Raytheon: A Stock on the Brink of a Big Move

Jun. 1.11 | About: Raytheon Company (RTN)

Raytheon (NYSE:RTN) is in an interesting position, as both the company's economic prospects and technical indicators can shift either way.

On the bullish side, Raytheon has experienced growth in selling its products to militaries in emerging Asian nations. While China's military is mostly supplied by state owned companies, India and Pakistan have been increasing their purchase of Raytheon's defense technology. Pakistan has been buying missiles from Raytheon and India has been purchasing the company's radar systems. India has been vigorously looking to increase its military strength as its neighbor China and Pakistan are some what hostile. Pakistan also has a strong interest in this arms race to compete with rival India. Tensions in South Asia are rising due to religious strife, argument over the disputed Kashmir region and historical rivalry between the nations since partition.

Despite several peace talks, there is a realistic chance (not the most likely outcome though) of an extended conflict with India against Pakistan in the next decade with possible Chinese involvement. This would be a boom for American defense contractors such as Raytheon that supply weapons to both sides. Also Raytheon has an extensive business relationship with Saudi Arabia. The Saudis spend 10% of GDP on national defense which one of the highest rates in the world and the recent unrest in the Middle East along with the prospects of possible American retreat in Iraq may make the Saudis extend force in the region. Another nice bonus about Raytheon is that they pay a solid dividend of 3.42%, but its financial condition does not differ significantly from competitors such as Lockheed Martin (NYSE:LMT), Northrop Grumman (NYSE:NOC) or General Dynamics (NYSE:GD).

On the other hand, Raytheon may also encounter significant weakness in the near future. 80% of its revenues are dependent on the defense spending of the U.S. government. With the debt ceiling failing to pass in Congress and fiscal conservatism growing popular among voters, spending cuts are likely to happen. The passing of Osama Bin Laden, and the President's de-emphasis on the war in Iraq make the defense budget a likely target for budget cuts. The U.S. spends nearly three times as much on military expenditures as the next three largest military budgest combined. With half of this budget, America can still be the dominant military power and save a lot of money doing it. This is obviously bad for Raytheon and can send the stock and dividend significantly lower.

Technically the stock is on edge too. Moving averages and a strong supporting trend line are bullish, yet Raytheon faces a strong resistance at around $52 per share which it has not been able to close above since 2008. I think that if Raytheon can break through, it will have a significant run up. However, if it forms a triple top here expect a big move down.

Overall, what should investors do with Raytheon? A geopolitically dangerous world is a positive, but significant defense spending cuts can derail the company for years to come. With volatility relatively low, I say buying a straddle on Raytheon here is the best bet. A strong technical resistance at $52 and the budgetary debate resolution will be two strong catalysts that swing this stock either direction.

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