Matthew Potter's  Instablog

With the expected decline in U.S. defense spending there is going to be a great deal of pressure on the big industrial defense contractors. At the same time analysts are focusing on their dividends as the best play for them.

Lockheed Martin (LMT) already pays $4.00 a year and leads the big contractors such as Boeing (BA), Northrop Grumman (NOC), Raytheon (RTN) and General Dynamics (GD) who have a range of $2.00 to $1.60.

NOC is predicted to raise their dividend in the near term based on historical data. The other companies may follow as all experienced flat revenue in 2011 but were able to increase earnings due to cost cutting. Without dividend increases they may not be attractive to investors.

Many of the companies like NOC and LMT are also utilizing stock buy backs to help with their valuations.

All the current indications are that these companies will have little change in their stock prices so potentially there will be changes to their dividends.

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

L-3 Communications (LLL) expanded its electro optical business by completing the acquisition of Kollmorgen from Danaher Corporation. The transaction closed for a price of about $210 million. Kollmorgan primarily makes optical systems for U.S. and other nation's submarines.

L-3 already has a growing electro-optical sensor business and the addition of Kollmorgen will only add to that growth. In their most recent quarterly report the company reported earnings of $2.72 a share on net sales of $4 billion. This was an increase of earnings of twenty-eight cents over the previous year. Interestingly the Electronics Systems division of the company where Kollmorgen will fall had a decline in net sales of $110 million in 2011 primarily due to less demand for night vision products, power devices and the lack of revenue from technology licenses. The division did, though, sell $43 million more in Electro-Optical / Infra-Red (EO/IR) products.

Kollmorgen is estimated to add sales of $160 to $170 million and earnings of up to $30 million for L-3. This additional revenue will help offset any further drops in sales by the Electronics Systems part of the company.

The addition of the company to L-3 allows them to expand their overall market share of the EO/IR business. With the expected reductions in U.S. defense spending the more diverse product line and markets should help L-3 maintain its sales and earnings. For 2012 the company is predicting $14.4 to $14.6 billion in sales and earnings per share (EPS) of between $8.35 and $8.55. This compares to sales of $15.17 billion in 2011 and EPS of $8.77. Clearly L-3 is expecting some contraction in the defense business in the coming year. This estimate does not include Kollmorgen.

As will all of the defense industry L-3 will have to adjust to the changing market in 2012 and one way of doing this is through M&A. The addition of Kollmorgen not only adds revenue and earnings but also increases their exposure in the EO/IR market while reducing potential competitors. There should be more moves of this type by defense contractors as they make moves to cushion the changes in spending.

Photo from Daniel Garcia Neto's flickr photostream

Read more: http://www.defenseprocurementnews.com/2012/02/09/l-3-expands-electro-optical-business-with-acquisition-of-kollmorgen/#ixzz1lszMTYND

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

Additional disclosure: This also appeared at Defense Procurement News.

The U.S. Army's rotary winged force has made great contributions to the fighting in Iraq and Afghanistan and has suffered some losses in these missions. The primary threat in those actions were small arms and machine gun fire but there was some use of surface-to-air missiles. The aircraft are fitted out with threat detection and jamming equipment and the Army plans to continue its investment in new systems for this mission.

With that two contracts were awarded last week to begin development of a new system that will jam or misdirect infra-red guided missiles which home in on the heat signal of the helicopter. The Common Infrared Countermeasure (CIRCM) program once it goes into production could be worth several billion dollars due to the number of Army, Navy, Marine Corps and Air Force helicopters that could have the system installed.

The two contracts to Northrop Grumman (NOC) and BAE Systems (BAE:LSE) will allow the company's to develop their proposed solution to the CIRCM requirements. They both have a value of around $38 million. Once these contracts are complete the Army will evaluate the proposed solutions and then choose one to go into Engineering & Manufacturing Development (EMD) to begin production and installation.

The CIRCM program was considered so valuable that proposals were received from ITT Exelis, Lockheed Martin (LMT) and Raytheon (RTN) as well. All of the companies that bid have experience with airborne jammers and protection systems.

Even though the U.S. defense budget is facing large cuts over the next five to ten years programs like this still need to be developed and introduced. There exists a large fleet of aircraft that will remain and they need to be updated to face improved threats from around the globe. If CIRCM is cut in the future it might be to stretch out the development or production so that the annual program cost is lower but eventually the desired result is achieved.

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

Additional disclosure: Also appeared at Defense Procurement News.