L-3, Lockeed Martin, and Raytheon: Short-Term Outlook Is Positive

One of the most stalwart industries in recent times – and continuing to look pretty strong going forward, as well – is the U.S. aerospace and defense group. We sat down with Zacks senior analyst Jon Kolb to find out which specific stocks he finds most appealing for the near term.

We notice you’re still bullish on several defense stocks. What’s the story behind this group these days?

First, it may be a good idea to give our readers an idea of how this industry is structured. The U.S. defense industry is believed to contain three tiers of defense contractors. The first tier is dominated by five large prime system contractors: The Boeing Company (BA), Lockheed Martin Corporation (LMT), Northrop Grumman Corporation (NOC), Raytheon Company (RTC) and General Dynamics Corporation (GD), all of whom compete for major platform programs.

The second tier defense contractors comprise generally smaller products and niche subsystems contractors, as well as traditional aerospace and defense companies, together with the non-core aerospace and defense businesses of certain larger industrial conglomerates. The second tier includes L-3 (LLL), Honeywell International (HON), Rockwell Collins (COL), Harris Corporation (HRS), ITT Industries, Inc., the North American operations of BAE Systems PLC, Alliant Techsystems (ATK), United Technologies Corporation (UTX), Computer Sciences Corporation (CSC), Science Applications International Corporation and United Defense Industries Inc.

The third tier represents the vendor base and supply chain for niche products and comprises numerous smaller publicly- and privately-owned aerospace and defense contractors.

So among these companies in your coverage, which ones are you most positive on?

Well, LLL is the aerospace and defense supplier with the broadest and most diverse product portfolio. It primarily competes with the second and third tier defense contractors. It supplies its products and services to all of the five prime system contractors. The primary competitive factors for LLL’s businesses are technology, research and development capabilities, quality, cost, market position and past performance.

L-3 Communications registered strong operational and financial results in all four quarters of 2007. The company delivered growth across multiple business segments. Along with stable operating performance, a healthy backlog position and a favorable industry outlook prompted management to raise 2007 sales, earnings and free cash flow guidance.

This growth trend is expected to continue through 2008-09 due to an impressive product portfolio. Earnings growth will come through both organic and accretive acquisitions. Accordingly, we reiterate our BUY recommendation on LLL common stock with a six-month target price of $120.

Interesting. What other Buy recommendations have you issued recently?

Recently I reiterated my Buy on Lockheed Martin, the largest defense contractor in the world. Solid operating results, via existing and new contracts – both domestic and international – coupled with the success of its C-130J and F-35 aircrafts continue to deliver strong earnings and cash flow growth. Management increased its 2008 earnings guidance, which supports the bullish outlook. Additionally, the company’s dividend was recently increased by 20%.

Most recently, Raytheon was also recommended with a Buy rating. This company offers investors strong order bookings, an improving balance sheet, growing cash flow, above-industry-average ROE and one of the highest dividend yields in the industry. Buoyed by excellent 2007 4th quarter results, the company raised its 2008 outlook.

Going forward, however, concerns about the long-term growth of defense spending in the face of continuing budget deficits and related to the company’s program execution remain significant risks. However, we note a bias to outperformance and have a six-month target price of $71.75.

Jon Kolb is a senior analyst covering the aerospace & defense industries for Zacks Equity Research.

Comments

[BluDog]

L-3 is Not Level-3. They are 2 completely different companies. Your article title in incorrect