Harris Corporation Is Now In Value

| About: Harris Corporation (HRS)

Harris Corporation (NYSE:HRS) provides communications and information technology to government, defense and commercial clients around the world. It was founded in 1916 and is based in Melbourne, Florida. It is one of the top 100 federal contractors.

Some of the offerings of HRS include secure tactical radio communications for military, defense and other government organizations, as well as complete communication systems for defense, national intelligence, federal and civil customers. The company also serves TV stations and networks; cable, satellite, telecommunications and other media content providers; and sports and entertainment organizations, providing integrated network solutions and broadcast communications.

Recent Performance

HRS has grown EPS from $0.63 to $4.67 over the last 10 years representing an impressive 22% growth rate. It has generated $3.3B of cash flow over the past 10 years versus $2.8B of total net earnings. See the below graph - importantly during the downturn in 2009 though the company's reported EPS dropped drastically, it maintained its strong cash flow and reported reasonable normalized earnings (which ignore results of discontinuing operations).

HRS Earnings
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Net debt to equity has generally been low throughout the last 10 years, though it has been increasing of late. HRS has been taking on debt to fund both acquisitions and also to buy back its own shares. Using debt to buy back shares is a tad unusual and typically not desirable, but the company sees it as an opportunity to exploit low interest rates. Its strong generation of cash flow allows it to easily service its loans, and currently its net debt to equity is a high but manageable 68%

The company has grown its dividend per share from $0.1 to $1.00 over the last 10 years, achieving a 26% growth rate. Currently HRS is offering investors a 2.7% forward dividend yield while the company's payout ratio is at a very sustainable 21%.

Quality Rating

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Though EPS has grown at an average compounded rate of 22% per annum, the EPS growth criteria in the above considers consistency of earnings growth. For HRS some years have been great and some poor - its inconsistency has cost the company in the Quality Rating score. The net debt to equity score takes into particular consideration the current state of the balance sheet more so than how it looked in the past. Currently the company has a rather high net debt to equity ratio.

Intrinsic Value

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The company is not offering a huge Margin of Safety at the moment, but due to its good Forecast Average Normalized Return on Equity, its Intrinsic Value is expected to grow meaningfully in the coming years.

HRS IV Graph
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HRS is now offering a margin of safety. Of course, when a stock becomes "in value" for the first time it usually comes with a catch - the catch for investors in HRS is the uncertainty surrounding potential US military budget cuts. Over 70% of HRS's revenue comes from the US government. US military spending as a % of GDP has generally been declining for the past 60 years and that trend is likely to continue. Being an election year the topic will be raised from time to time, and some uncertainty will linger as to how the party in power will want to approach the issue after the election. But the commentary at this stage suggests that any budget cuts that are on the horizon for the U.S. military will be in the order of a few %. Some believe the U.S. will go to war with Iran in the coming year or 2, but that's not a topic of discussion for this article.

Capital Management

If HRS was unable to grow its revenue from its fiscal 2011 values it would be expected to raise its dividend. If the company achieved the same numbers as it did in 2011 year after year and raised its payout ratio to 100% instead of the current 21%, its dividend yield based on current prices would be 11%. This is unlikely to ever happen, but it's important to understand various (hypothetical?) scenarios such as this one in order to understand the options available to the company should it fail to achieve revenue or earnings growth.


For the last few quarters, HRS has grown its revenue through acquisitions while organic growth is halted due to global economic weakness - governments around the world are adopting austerity measures causing some headwinds for companies like HRS.

But HRS has won some decent communications contracts lately with fire and police departments - and by doing so has taken some of Motorola's dominant market share. Given that HRS is a small player in this market compared to Motorola, significant scope for growth exists. Other areas of growth include the oil and gas industry where offshore communications are important for ever expanding exploration activities as well as production operations.

All in all, investors should not expect HRS to achieve anywhere near the same growth rates in the coming few years as it has in the last 10 years. Its future growth is uncertain, and much of it depends on the success of the company's R&D efforts (the majority of which is funded by the U.S. government). And while prospects for growth remain scarce, the company should be expected to raise its payout ratio. Regardless, investors will want to see a larger Margin of Safety available (which will correspond in a higher dividend yield) prior to a purchase.

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

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