The last quarter was a good one for the aerospace and defense industry. Most companies beat earnings estimates and have lifted their guidance for the rest of the year.
Beyond this year, it seems that aerospace and defense is poised to continue growing as threats to countries from the Middle East to Europe continue to rise. Don't look for that to change under a Trump presidency. Even though he has pushed other countries to pay a greater share of their own defense budgets, they will still need to get their arms supply from somewhere, and the U.S. defense industry is the most likely place.
Raytheon Company (NYSE:RTN) is set to benefit from this situation. It has the potential to grow earnings, and the shares can be bought at a decent price based on the company's current financial situation, earnings and cash flow.
The defense contractor is the largest guided missile manufacturer in the world and is the third-largest U.S. defense supplier.
Raytheon recently reported earnings that beat estimates and raised its earnings forecast for the rest of the year because of a rise in bookings for those missiles. Raytheon's backlog increased to $35.31 billion.
The company derived a third of its revenue outside the United States. Countries in the Middle East and Africa contributed a large portion. This region is currently investing heavily in arms as the countries protect themselves from threats to their sovereignty. I do not see this trend reversing itself anytime soon.
Raytheon is also in negotiations with Poland to upgrade its missile defense system. The contract could net the company upwards of $5 billion.
It also has a big hand in the iron dome air defense shield used by Israel. This will be very lucrative for the company, considering the United States just signed the largest pledge of military assistance ever to Israel.
Two other areas Raytheon is involved in - cybersecurity and drone technology - are a good reason it is positioned for earnings growth in the future. These are two areas in defense that should receive a lot of investments from governments around the world.
The company has invested over $3.5 billion in cybersecurity, and it recently signed several deals in this area. This is a growing area of defense spending, as the threat of hacking has increased over the years. With the United States government's concern over cybersecurity threats, Raytheon should keep on reaping the benefits of these investments.
The company makes the radar detection systems that go into the Predator and Reaper drones used by the United States. It also makes its own drones. These are smaller drones designed to be used once. With the drone market set to grow significantly in the future, Raytheon is in a good position here too.
Raytheon has risen about 15% over the last year, outperforming the market's return of about 5%. However, it still has a P/E ratio of about 19.5.
It also consistently generates a lot of cash - about $2.5 billion of operational cash flow annually. Pretty good for a company with about $23 billion in revenue. With results like that, Raytheon can keep on investing in growing areas, such as cybersecurity and drones.
With a decent 20.31% return on equity, it should have plenty of earnings power going forward. The balance sheet looks good too, with a modest 0.5 debt-to-equity ratio.
Looking forward, I believe Raytheon can grow earnings significantly over the next 5 years. Somewhere in the area of 15-20% would not be unreasonable given the industry's growth prospects, Raytheon's strong product position, balance sheet, its ability to generate cash and ROE. That would make the PEG approximately 1.15 (19.5/17), which compares with a PEG of 1.4 for the S&P 500.
Therefore, Raytheon's P/E should be about 24 (1.4*17). That translates into a valuation of $179 per share. I recommend buying RTN stock given that it is trading at $146.04 right now.
To summarize, the aerospace and defense industry is looking good for the rest of this year and next. Raytheon is benefiting from this and is in the key growth areas in the industry. It is reasonably valued and should appreciate in value over the near and longer term. Therefore, RTN is a stock that is a safe bet in an unsafe world.
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. I have no business relationship with any company whose stock is mentioned in this article.