Harris Promises Suitable Growth

Summary

• Harris has delivered strong fundamental performance during Q2 and H1 2019.
• Harris has outpaced the S&P 500 index.
• The company has a suitable valuation and is poised to grow.
• Despite strong fundamentals, the technical price chart hints towards some correction, and it would be best to buy the dips.

Harris Corporation (HRS) provides solutions related to air traffic management, tactical communications, avionics and electronic warfare, geospatial systems and services, and space and intelligence. Headquartered in the US, its products/services are broadly categorized into 3 business segments namely communication systems, space and intelligence systems, and electronic systems (Figure-1). The company's growth is predominantly based on providing innovative technological solutions in the above-mentioned business segments.

Figure-1 (Source: Company Website)

Thesis

In this article, I have evaluated the technical picture of HRS that indicates the stock is slightly risky at current prices. But that's just the technical picture. A fundamental analysis that follows indicates otherwise and suggests that HRS has solid growth potential due to the very nature of its operations, and the demand for its products in the US defense industry. Moreover, the company has a suitable valuation among peers. It follows, therefore, that HRS is a buy even at current prices. However, for maximum returns (and considering the technical discussion) I believe a suitable entry point would be below $150.

The technical picture of Harris:

At the time of writing, HRS last traded at ~$157. Given the 52-week price range that lies between $123.24 and $175.5, HRS is currently trading slightly above the median value of the 52-week range. From a technical viewpoint, I consider stocks that trade lower than the median value of their 52-week range, as safer investments. Based on that, HRS appears to be slightly pricey at current prices and the technical price chart (Figure-2) also suggests that the recent strength witnessed in the share prices could meet resistance at some point.

Figure-2 (Source: Finviz)

HRS's fundamental strength (discussed later) supports an investment case even at the current prices and based on the analysts' recommendations (Figure-3), the stock is a buy with a short term target price of ~$169. Nonetheless, I suggest waiting for a suitable dip to enter this stock that promises to be suitable long term growth.

Figure-3 (Source: Sharewise)

Fundamental analysis:

Overall business performance: In terms of revenue, the company has depicted solid growth. HRS's Q2 2019 revenue amounted to ~$1.7 BB, recording a 9% increase Y/Y. The orders placed with the company during Q2 amounted to ~$1.766 BB compared with ~$1.39 BB during Q2 2018 (increasing by ~27% Y/Y). For the half year ended December 2018, HRS’s revenues and orders grew by ~9% and ~2% respectively.

Similarly, the company's net income profile has improved way better than its revenues. During Q2 and H1 2019, HRS's net income recorded a whopping increase of ~72% (from $131 MM to $225 MM) and 51% (from $290 MM to $438 MM) respectively. HRS has been able to improve its operating margins and EBIT margins (Figure-4), and that has helped propel the company's growth.

Figure-4 (Source: YCharts)

Segment performance: Have a look at Table-1 that summarizes the revenue and income growth for HRS's individual business segments during Q2 and H1 2019. This table shows that during Q2, the Electronic Systems segment has shown massive improvement in terms of operating income, achieving double-digit Y/Y growth in income (~21%) and posing a healthy outlook. Next in line is Space and Intelligence Systems segment, that achieved 15% growth in operating income with a respective 11% growth in Q2 revenues.

Table-1 [Prepared by Aitezaz Khan for Seeking Alpha]

Nevertheless, all the 3 business segments of HRS have portrayed impressive growth rates in operating income that exceed the Y/Y growth in revenues (in terms of Q2 2019 results). In my opinion, the strength in revenues and income supports an expectation of future price gains.

Business Growth outlook: As mentioned earlier, the company's business growth is based on consistent innovation in its technological solutions. HRS needs to invest heavily in R&D (read: Research and Development expenditures) to continue providing solutions that meet the modern needs of its customers. During the FY 2018, HRS allocated ~5% of its revenues for funding its R&D activities (Figure-5).

Figure-5 (Source: Annual Report 2018)

During the FY 2019, I expect HRS to enhance (or at least maintain) this proportion of R&D-to-revenues. Given that HRS increased its revenues on a Y/Y basis (as discussed earlier), I believe it's likely to increase its spending in R&D, which should definitely fuel business growth, as rapid innovation is the key to success in the industry. Moreover, since HRS has witnessed an improvement in its FCF profile (Figure-6), it won't be a problem for the company to increase its R&D spending.

Figure-6 (Source: YCharts)

Furthermore, HRS has significantly transformed its debt profile during the past 12 months. At present, it has a negative net debt issuance of ~$133 MM (Figure-7), which is indicative of a strong liquidity position as the company has more cash than is required to settle the outstanding debts. This should go well with the significant free cash flows and support the company's R&D expenditures.Figure-7 (Source: YCharts)

Moreover, the WSJ expects the US government to increase its spending in defense sector. In my view, this will turn favorable for companies in the Aerospace and defense industry (including HRS). For HRS, this is likely to result in further growth in revenues.

HRS outperforming the S&P 500 index: On a different note, an investment case in HRS is also supported by the fact that during the past 5 years, HRS has generated superior cumulative returns than the S&P 500 index. Have a look at Figure-8 that shows that S&P 500 has gone up by ~88% since FY 2013. In contrast, HRS has witnessed a sharp hike of ~227% during that period.

Figure-8 (Source: Annual Report 2018)

Valuation

As shown in Table-2, HRS has a suitable valuation among selected peers. For peer analysis, I have compared HRS with L3 Technologies (LLL), Raytheon Company (RTN), and Northrop Grumman Corporation (NOC). On the surface, HRS’s PE ratio might appear to be on the higher side. However, its earnings have shown massive growth during the past 1 year. The table also shows that HRS has a suitable PB valuation in line with the industry standards (with the exception of LLL). In my view, LLL has a different case; it’s trading cheaply but lags behind the other competitors in terms of earnings, and dividends.

Table-2 [Prepared by Aitezaz Khan for Seeking Alpha]

Moreover, HRS is going for a merger with competitor LLL. This merger is expected to take place towards the mid of calendar year 2019 and it is expected to create synergies that should propel business growth, as the merged company would emerge as a global leader in defense and communication technology.

Conclusion

HRS has delivered consistent growth in business performance. It’s growing in terms of revenues and has considerably improved its margins, and a favorable outlook of the US defense industry supports an expectation of future business growth.

The company has also invested heavily on R&D to provide modern (and innovative) solutions for its clients. It’s part of the S&P 500 index but its cumulative returns have outpaced the returns generated by the index. Moreover, the company has a suitable liquidity position and its valuation comes at par with peers. In my view, all these factors support an investment case in a company that provides reasonable upside potential.

However, based on the technical price chart there is some room for correction and I believe it would be best to buy the dips.

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