Raytheon: Wait For A Pullback Then Go Long

| About: Raytheon Company (RTN)


Raytheon operates in the shadows of the larger defense contractors and therefore doesn't get much attention from investors.

The company had a great 2015 and is estimating great growth in 2016 and beyond.

They have a well diversified portfolio of products and are growing internationally and domestically.

Their foray into commercial off-the-shelf cyber security products will give Raytheon access to a lucrative and long-lasting market.

The stock price has climbed considerably in the last week due to their earnings beats and 2016 outlook, wait for it to pullback to initiate a position.

During times of geopolitical uncertainty and global instability, defense companies are popular destinations for investors. They offer a measure of certainty and stability that is otherwise hard to find and they tend to perform better when the world seems to be falling apart. While I'd argue the world is actually in pretty good shape, defense companies are nonetheless rising in popularity as news headlines concerning North Korea, Iran and ISIS grab the front page. Raytheon (NYSE:RTN) is a less covered defense company, but one that deserves your attention.

Raytheon recently posted its fourth quarter and full 2015 results and they were great. They beat EPS estimates for the quarter by $0.12 coming in at $1.93 with revenue coming in-line but increased year over year by 2.6%. Their $6.3B in revenue for the quarter brought yearly revenue to $23.2B, a 2% increase over 2014. The EPS for the year was $6.75 as a result of a $.25 reduction due to the Websense acquisition, with the adjustment EPS dropped just 3%. Other notable broad numbers are a 4.9% rise in bookings and 1.8% increase in net sales. Breaking down the individual segments provides some more good news.

Integrated Defense Systems brought in $6.1B in sales which was a 5% increase over the year. Despite the growth in overall sales, the operating income dropped 7% due to dropping margins. The growth in sales came largely on the backs of the Patriot Missile Defense System which remains in high demand throughout the world. For those unaware, this system intercepts and kills ballistic missiles. In 2015 alone this system intercepted and defeated over a dozen missiles which would have otherwise hit their targets and caused property damage and maybe loss of life. For Raytheon, the beauty in the system lies in the training needs of the customer that comes with every contract and that countries will not go cheap on or hesitate to push the button. The cost of a missile kill vehicle is much less than the potential loss of property and life. As regional instability rises in Europe, Asia, Africa and the Middle East, the Patriot will only rise in demand as nations look for effective deterrents for aggression from their neighbors.

Their Intelligence, Information, and Services segment experienced a 3% drop in overall sales but still had $6.5B to contribute. Operating income actually rose about 18% on improving margins, 80 basis points coming from the eBorders settlement with the UK. There are many products that Raytheon offers in this segment which can reach over into the civilian sector and over international lines. Raytheon provides air traffic control systems, border control and management systems, and critical infrastructure systems such as toll-booth collections. With these products and services RTN is able to scale its business into many different markets and reach into lucrative civilian sectors. With the Syrian refugee crisis, I can see their border control products becoming more popular despite the hardships it faced in the UK.

The Missile Systems segment was another bright spot for RTN bringing in $6.5B in sales with an 8% improvement in operating income thanks to great margins. This portion of their business is the most profitable and also sports some great margins which continue to slowly improve as their systems mature and require less research and development. Missile platforms such as Paveway, Stinger, Evolved Seasparrow, Rolling Airframe and TOW fill this space, along with the incredible Phalanx. The Phalanx is more like a Gatling gun that overdosed on horse steroids coupled with an advanced targeting system to intercept missiles targeted at our ships and kill them with a literal wall of ordnance, but it falls under the missile segment. With such a great diversity of systems available from RTN, the profitability will continue to rise as more nations place an emphasis on their defense to deal with regional instability.

Space and Airborne Systems added $5.7B in net sales which was 5% less than 2014. The slowdown in international sales ate into the overall profitability for this segment, but it does remain strong going into 2016. Most of this portion is RADAR and satellite systems which will constantly need upgrades and maintenance. Nations are becoming exceptionally protective of their airspace with a proliferation of air power in several kinetic regions, and are also realizing the importance of protecting their sovereign waters from encroachment. Reliable and robust RADAR and detection systems are mutually beneficial to both the hosting nation and those exercising their power next door as it can prevent erroneous engagements on sea and in the air.

This next segment is one that has a lot of promise for Raytheon. Forcepoint is the name given to the Raytheon/Websense Cyber Security program. Though the numbers are small, this is a rapidly growing portion of their business and brought in $328M in sales in 2015, an increase from $104M in 2014. Though it must be considered that the segment is entirely different from what it was last year, it is encouraging to see RTN scale this product effectively. Forcepoint was born out of the acquisition of Websense in May of 2015 and reinforced by their purchase of Stonesoft in the quarter. The margins will be great going into 2016 at about 15% and will continue to grow as cyber security becomes the main focus for governments and private companies. With Forcepoint, Raytheon is able to market a commercial off-the-shelf program domestically and internationally, this will prove to be highly beneficial to them in the long-term.

Their 2016 outlook has ample growth forecasted. They see their sales increasing to up to $24.5B, EPS as high as $7.00, operating cash flow in the $3B range and overall shares dropping by about 7-9 million. As more and more countries modernize their defense to meet rising threats and militarization in their regions, Raytheon will profit nicely. Several programs from other large US defense companies will also benefit RTN as they sell many components to all of those projects. Despite all the growth, a great 2016, and longer outlook, if I weren't already invested I would wait to enter at a more attractive valuation. They are slightly overvalued based on historical P/E.

The FAST Graphs chart gives us a great idea of how RTN typically trades. Right now with a P/E of about 18.9, it's slightly more expensive than it normally is, the great Q4 earnings ramped the price up rapidly. The company trades at around 16x earnings normally, so if they earn their full $7.00 in 2016 that would mean $112 is a very fair entry point. The comforting fact is that RTN does well in just about every market and earnings are not affected by recessions, so starting a position at any price is a solid long-term investment. With a well-covered 2.1% yield and exceptional growth prospects, I'll be adding to my RTN position as the opportunities present themselves. Thank you for reading and I look forward to the discussion in the comments. As always, best of luck to all of you!

Disclosure: I am/we are long RTN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I must urge you to do your own due diligence. This article is meant for educational purposes only and is not to be taken as investment advice as I am not your financial adviser and have not considered your own personal situation as a fiduciary.

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