Raytheon Company: Guns Or Butter?

May.21.12 | About: Raytheon Company (RTN)

The U.S. is embroiled in an unpopular war half-way around the globe. The enemy is elusive and persistent. The U.S. has no clear military strategy and no clear exit strategy. The country is in the midst of social upheaval. Government policy is to spend billions upon billions to address domestic issues. There is not enough money to support both agendas. The government needs to make a choice: guns or butter. Support the war or the domestic agenda. This scenario is as current as today's headlines but it was also the debate in 1965.

The end of the war in Vietnam and the end of the Cold War, a decade later, was supposed to bring a so-called "Peace Dividend." The idea that once peace broke out there would no need to support a large and increasingly expensive military. These savings could be directed to solving enduring domestic social problems. Sadly, the world does not work this way and a strong military is still necessary to defend our country, our citizens and our economic interests around the world. To paraphrase Mark Twain reports of the death of the military-industrial complex are greatly exaggerated.

Raytheon Company (NYSE:RTN) is one of the top five defense contractors. The company product mix addresses needs in Command, Control, Communications and Intelligence Systems (C3I). Raytheon is organized into six product groupings: Integrated Defense Systems (IDS); Intelligence and Information Systems (IIS); Missile Systems (MI); Network Centric Systems (NCS); Space and Airborne Systems (SAS); and, Technical Services (TS).


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Raytheon reported 1Q12 results that beat analyst expectations. Analysts were looking for EPS of $1.16 and the actual is $1.33. This represents a 25% in crease over EPS for 1Q11. EPS for the TTM ending 04/01/2012 are $5.56 versus $4.68 in the year-ago period. On the other hand, sales were down about 2% to $5,938.0 million in 1Q12 from $6,052.0 million in 1Q11. For the twelve month period ending 04/01/12, sales were down about 2% to $24,733.0 million and below FY11 sales of $24,857.0 million. Looking ahead, analyst forecast sales for FY12 in the range of $24,045 million to $25,058 million. The average of these estimates is $24,557.7 million. The company is providing guidance for per share earnings from continuing operations in the $5.00 to $5.15 range. In the last twelve months, diluted earnings per share from continuing operations were $5.56.

The company announced a dividend increase of $0.28 bring the indicated dividend to $2.00 per share. At the current share price, the dividend yield be about 4.0%. The company's five year average dividend yield is 2.64%. This disparity may be indicative of share price undervaluation.

The balance sheet is in good shape with long term debt being less than 3X free cash flow and more than ample to cover the dividend. One area to keep an eye on is the ratio of inventory to sales. The ratio has crept up to 21% from its five year average of 19.2%.

Looking to the future, how will the guns or butter debate play out? We already know that the Pentagon has scheduled massive expenditure reduction over the next ten years. Additionally, our leaders in Washington have baked into their last fiscal plan compromise automatic cuts should they not reach agreement on the next budget. All this creates uncertainty over the dimensions of future Pentagon funding cuts.

Raytheon, like its competitors, is hedging by expanding its international sales and by making acquisitions into new areas that may see expenditure increases. The company acquired Henggeler Computer Consukltants, Pikewerks Corporation and Ktech Corporation.

The company is undoubtedly facing headwinds. So far, it has been successful at reducing costs which will help the bottom line even as it enters new markets and introduces new products. At the end of the day, the choice is not between guns or butter. Domestic and security issues are two sides of the same coin. We cannot address our domestic issues if our nation is not secure and we cannot secure our nation if we are not strong at home. The pendulum swings both ways.

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