Following on from our previous article, "Defense Industry Uncertainty," we would like to focus the attention of an interesting case of company which is potentially well positioned to cope with the developments in the industry. Its name is Raytheon (RTN).
It is a leader in defense, government electronics, space, information technology, and technical services. The company operates in six principal business segments which reflect the diversified nature of the business.
In our view, Raytheon offers less reason for concern than its peers, as some of the potential weaknesses we have outlined in "Defense Industry Uncertainty" article seem to be (partially) mitigated by its business model. Furthermore, it presents some encouraging factors which are consistent with a more positive outlook. Let's analyze them in more detail.
Raytheon is probably the most international company among the big US defense contractors, since 25% of its Total Sales in 2011 were made in foreign markets, mostly Asia/Pacific and MENA. This simple piece of data leads to two conclusions: firstly, the company possesses a capability of international projection which translates in the availability of overseas business networks as well as lobbying ability with foreign governments. Secondly, the geographical diversification of their sales, compared to the industry and in relative terms, allows the company to enjoy a slightly reduced dependency on U.S. budget decisions. Despite the U.S. still being the core market, Raytheon does have a valid passport and it has proven capable of using it to generate business opportunities. Shall the outlook ever become too gloomy for the U.S. defense industry, it will not be moving into an unknown territory.
The diversification discussed above is not limited to the geographical dimension, but extends to products too. A quick look at the lines of business operated by Raytheon reveals the portfolio of capabilities span across various technological areas: electronics, intelligence systems, communications, information systems. It is self-evident Raytheon can lead programs in many areas and its business model is sufficiently flexible to somewhat mitigate potential government budget cuts by distributing the risk across a number of expense chapters.
In addition to this, according to the President's FY2013 budget request, the programs where Raytheon is the main contractor will register a decrease less significant than others. This circumstance reinforces the conclusion stated above on the benefits of a balanced portfolio of businesses.
Not only this, but the range of the varied competences may be exportable and reusable in other industries, thus enabling the management to consider opportunities for diversification. This may not be a painless or efficient operation to complete (see the section in the "Defense Industry Uncertainty" article). Still, it offers breathing space, shall the moment of truth ever come.
Another reason for looking at Raytheon with more benevolent eyes lies in the favorable operating income shown in the past years. Calculated in both absolute terms as well as EBITDA %, it shows a steady positive development which is higher than the Sales growth. Predictably, its relative growth is also superior than the industry average but the element of interest is the large cash reserve (over $4B) available, for example, to finance improvement programs of the operations. Efficiency gains are possible and attainable.
Despite these attractive factors, there are still at least some critical points which deserve to be looked at with extra care.
An analysis of the balance sheet, for instance, uncovers at December 31, 2011, goodwill and other intangible assets totaled approximately $13.2B, net of accumulated amortization. This item equals to approximately 51% of total assets. The menace becomes immediately apparent when considering that the regular review of the fair value could result in potentially unfavorable impairment of a magnitude that could severely damage the state of financial health.
Moreover, the company states it has no short term debt but has a long-term debt position worth $4.6B in 2011, rising at an astonishing CAGR of 56% since 2008. This peculiar capital structure may spark uncomfortable questions…
In summary the company is well diversified but with questions regarding the state of its finance it is, overall, an attractive company for a long position despite the many challenges in the US defense space.
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