Raytheon Company (RTN)
- Share Price: $50
- Intrinsic Value: $69
- Buy Below: $52
Business description and background:
Raytheon Company , 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 a range of mission support services in the United States and internationally. The company offers integrated defense systems that include integrated air and missile defense, radar solutions, and naval combat and ship electronic systems; and intelligence and information systems that comprise defense and civil mission, enterprise intelligence, information security, and mission operations solutions, as well as special missions and technologies. Further, it provides space and airborne systems (SAS), such as intelligence, surveillance and reconnaissance systems; tactical airborne systems; space systems; and other SAS product lines. The company was founded in 1922 and is based in Waltham, Massachusetts.
Raytheon, with estimated 2012 revenues of $25 billion, is the world's sixth largest military contractor and a leading maker of missiles and radar. It does business through six segments. Raytheon conducts business through integrated defense systems, Intelligence and information systems, Missile systems, Network centric systems, Space & airborne systems and technical services.
Raytheon's primary missile and military electronics markets are driven by growth in the U.S. defense budget. Based on Department of Defense statistics, from FY 00 (Sep.) through FY 10, the (weapons) procurement and R&D budgets within the U.S. defense budget grew at 9.0% and 7.6% compound annual rates, respectively. We expect growth in defense budgets to flatten out or decline going forward, due to pressure resulting from high U.S. budget deficits and increased entitlements spending.
RTN ended 2011 with the lowest valuation among large cap defense universe despite a strong year-end rally. At 7.9x 2013E PAEPS (Pension Adjusted EPS), RTN trades at a steep discount to the average of the other large cap defense names. Despite decent stock performance in 2011 (9% total return, second best among the peer group behind LMT), RTN has been the cheapest stock among its peers for an extended period. It remains a top pick, and one can expect the valuation gap to narrow this year.
RTN's international prospects provide the company with a revenue stream that is independent of domestic fiscal concerns and positions the company well relative to peers with less international exposure. With an estimated 25% of 2011E sales derived from international customers, RTN has the largest international sales mix of its peer group. Overall, we forecast a 1% organic revenue decline for RTN in 2012 versus an average 5% decline for its peers and a 3% decline in investment account outlays. This relative top-line strength drives a more attractive earnings profile, and RTN is the only defense prime for which we expect EPS to grow in 2012. RTN's recent large debt offering and plans to contribute a substantial portion of the proceeds to its pension fund could provide upside to our numbers, and we believe this is in part responsible for the late-year rally of the stock.
RTN provided its initial 2012 guidance and, by and large, the guidance supports the outlook for the business. The company guided toward $24.8 bn of sales at the midpoint which was in-line with street view of a modest decline in the business. Operating margin in 2012 will benefit from reduced net pension expense as a result of the company's $750 mn contribution in Q4 but the company is guiding for its adjusted operating margin (which excludes pension) to decrease 100 bps from 13.2% in 2011 to 12.2% at the midpoint in 2012. Strong orders both domestically and internationally pushed the backlog to its highest level since 3Q10. At $35.0 bn, backlog was up ~$500 mn both sequentially and since year-end. Missile Systems looks particularly strong and its $2.3 bn of bookings in the quarter (33% of total bookings) were the second largest amount ever for the business. This order strength drove a large sequential increase in the segment's backlog which also stands ~$370 mn higher than its YE10 level.
The board of directors had authorized a share repurchase plan of up to an additional $2 billion of outstanding stock in July 2011. The buyback program is similar to a $2 billion program announced in March of 2010. As of July 3, the company had spent $1.2 billion on its shares under that program, according to public filings. The buyback program is gaining steam among lot of defense names and Raytheon is not long behind in the race.
For the 10 years ended 2010, RTN generated a compound annual growth rate (CAGR) of 4.2% for sales, 13.7% for earnings from continuing operations, 12.6% for earnings per share, and 3.5% for dividends per share. Return on invested capital (after-tax operating profit as a percentage of long-term debt plus equity) was 14.3% in 2010 and 16.7% in 2009, versus the Aerospace & Defense industry average of 15.7% and 14.6% in the respective years.
Management & Stewardship
Raytheon boasts of a strong management personnel in its comrade. William H. Swanson is the Chairman and CEO of Raytheon. Mr. Swanson has held increasingly responsible management positions, including: President from July 2002 to May 2004; Executive Vice President of Raytheon Company and President of Raytheon's Electronic Systems business unit from January 2000 to July 2002; Executive Vice President of Raytheon Company and Chairman and CEO of Raytheon Systems Company from January 1998 to January 2000. Mr. Swanson has around 23 years of experience in energy and governmental sectors. Jay B. Stevens is the Senior VP and secretary of general counsel since October 2002. In December 2006, he was also elected as Secretary of the Company. From January 2002 to October 2002, Mr. Stephens served as Associate Attorney General of the United States. From 1997 to 2002, Mr. Stephens was Corporate Vice President and Deputy General Counsel for Honeywell International, Inc. (formerly AlliedSignal, Inc.).
The management at Raytheon, like many other defense companies, holds a very thin position of the company. The management holds around 0.4% of the company.
We have used the DCF valuation using conservative estimates to arrive at the fair value of RTN at $69 which represents a 37% premium to current trading price.
Disclaimer: This discussion is for informational purposes and should not be taken as a recommendation to purchase any individual securities. Information within this discussion and investment determination of the author may change due to changes in investment strategy when warranted by changing market conditions, or if a security’s underlying fundamentals or valuation measures change. There is no guarantee that, should market conditions repeat, this security will perform in the same way in the future. There is no guarantee that the opinions expressed herein will be valid beyond the date of this presentation. There can be no assurance that the author will continue to hold this position in companies described herein, and may change any of his position at any time. We use or best efforts to obtain good data in our models, however it can’t be guaranteed that our inputs and data are correct. This is not a recommendation for readers to purchase shares in the above security without consulting your financial professional to discuss your own risk tolerance and objectives.
Disclosure: I am long RTN.