3 Defense Giants At A Discount

|
 |  Includes: LMT, NOC, RTN
by: Pragmatic Bear

One of the largest and most important sectors in the market is the defense sector. Recently, this sector has been in the crosshairs of politicians and pundits alike. This has caused the share prices of some major defense companies to fall to very attractive levels, while pushing their yields up. This is not to say that there are not areas of concern. With the budget battle heating, defense spending seems to be in the crosshairs. This is somewhat troubling, as the United States government is a major purchaser of all three of these companies. This has been reflected in the share prices recently, as all three companies are just off their 52 week lows. However, I am of the opinion that these are solid companies that are striving to become more diversified. This could prove to be a terrific opportunity to pick up some solid value stocks at bargain prices.

Some key factors I am considering:

Debt to Equity: The debt-to-equity ratio is a leverage ratio indicating the relative proportion of shareholders' equity and debt used to finance a company's assets. It reveals how a company has financed its assets. A low debt-to-equity ratio indicates lower risk because shareholders have claims on a larger portion of the company's assets. I normally look for a number below 60%.

Dividend Yield: The dividend yield is the sum of a company's annual dividends per share divided by the current price per share. I am looking for companies that are yielding above 3.50%.

FCF Payout Ratio: This ratio is the company’s current dividend per share (ttm) divided by its free cash flow per share. It gives the investor a clearer picture of the company’s ability to cover its dividend than the more traditional payout ratio. This is because free cash flow is much a harder metric for a company to manipulate, as opposed to net income. I look for a ratio in the neighborhood of 70% or lower.

Price to Owner's Earnings: This ratio looks at the relationship between the share price of the company and the free cash flow per share. I normally look for a multiple somewhere below 17.

Consecutive Years Increasing Dividends: One of the best ways to see how strong a dividend that a company has is to look at how consistently they issue and increase their payouts.

5 Year Average Annual Growth Rate: This is the average speed at which the dividend has grown during the previous 5 years. It helps us get an idea about how important the dividend is in the eyes of the company’s management.

The three defense industry stocks that I chose to analyze are Lockheed Martin (NYSE:LMT), Raytheon (NYSE:RTN), and Northrop Grumman (NYSE:NOC).

Lockheed Martin: engages in the research, design, development, manufacture, integration, operation, and sustainment of advanced technology systems and products in the areas of defense, space, intelligence, homeland security, and government information technology in the United States and internationally.

  • Debt to Equity - LMT has a very high debt to equity level of 153.01. This is far above the other two companies on this list, and is also much higher than I like to see in the majority of my investments.
  • Dividend Yield - Lockheed pays a quarterly dividend of $1.00 to its shareholders. The company's dividend was recently boosted to this level by a 33% increase in late September. This works out to give the company a current yield of 5.50%. This is the highest of the highest yield on the list. It is also higher than the 3.5% that I usually like to see from a company.
  • FCF Payout Ratio - At present Lockheed Martin has a ratio of 42%. This implies that its dividend is quite safe and there is still plenty of room for growth.
  • 5 Year Average Annual Growth Rate- The company has a fantastic growth rate for its dividend over the last 5 years at 21.05%. This is the highest value on the list and shows that management is really concerned with returning value to their shareholders.
  • Consecutive Years Increasing Dividends- Lockheed is a dividend challenger as it has consistently increased its dividends for the past 9 years.
  • Price to Owner's Earnings - LMT is trading at a 9.44 price to owner's earnings multiple. To me this implies that the stock is very cheap right now, as I normally look for a multiple of under 15.

Raytheon: together with its subsidiaries, provides electronics, mission systems integration, and other capabilities in the areas of sensing, effects, and command, control, communications, and intelligence systems, as well as mission support services in the United States and internationally.

  • Debt to Equity - RTN has a very low debt to equity level of 34.94. This takes the middle position on the list, and is also well below the 60% ratio I look for.
  • Dividend Yield - Raytheon pays a quarterly dividend of $0.43 to its shareholders. RTN reaffirmed its dividend and also announced a 2 billion dollar buyback plan. This works out to a current yield of 4.40%. It is a very solid payout and is above the 3.5% that I usually look for.
  • FCF Payout Ratio -Right now Raytheon has a ratio of 50%. There is still plenty of room for growth and it is well below the 75% level I look for.
  • 5 Year Average Annual Growth Rate- The company has a good growth rate for its dividend over the last 5 years of 11.64%. Of the three companies, RTN has the slowest growing dividend. However, a 10%+ growth rate is still very impressive.
  • Consecutive Years Increasing Dividends- Raytheon is another example of a dividend challenger, having consistently raised its dividends for the past 7 years.
  • Price to Owner's Earnings - RTN has a multiple of 12.28. By this measure it is the most expensive of the 3 companies. However, it is still below the 15 multiple that I look for.

Northrop Grumman Corp. : provides products, services, and solutions in aerospace, electronics, information systems, shipbuilding, and technical service sectors.

  • Debt to Equity - Northrop has the lowest debt to equity ratio of the three companies at 32.75. It signifies that it is the least leveraged and the most capable of covering its debts.
  • Dividend Yield - NOC pays a quarterly dividend of $0.50 giving it a yield of 3.91%. The dividend was last increased in March by $0.07. This represents the 8th consecutive year of increases for Northrop. Out of the 3 companies NOC has the lowest yield.
  • FCF Payout Ratio - The company currently has a free cash flow payout ratio of 28%. This is lower than either LMT or RTN's ratio. There is still a ton of room for growth, and it falls well below 75% that I normally look for.
  • 5 Year Average Annual Growth Rate- Northrop Grumman has a very nice 5 year average annual growth rate of 12.7%. The strength of the company's other metrics point to the sustainability of this growth.
  • Consecutive Years Increasing Dividends- Northrop Grumman is also a dividend challenger as it has consistently increased its dividends for the past 8 years.
  • Price to Owner's Earnings - NOC is trading at a 7.50 price to owner's earnings multiple. This makes it the most inexpensive as it is trading at a discount to RTN and LMT. To me this implies that the stock is very cheap right now as I normally look for a multiple of under 15.

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