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Harris Corp: Great Business Portfolio But Volatile Financial Performance

Summary

Harris Corp's stock has had a spectacular run over the last 2 years.

However, its financial performance over the last decade has been volatile.

Harris's balance sheet has issues that should not be overlooked.

Ferocious Rise

Harris Corporation’s stock had a spectacular run over the last 2 years when it went from $70 to $170, a rise of 140% in 2 years!

After hitting 170 in April, it cooled off a little, now hovering around 152, a 10% scale-back. Still expensive, mind you. The guided GAAP EPS for 2018 (its financial year ends in June) is $5.9 which makes it trade at almost 26 multiples. Expensive!

Seeing the furious rise of this stock I decided to have a harder look at it over a longer horizon. Certain trends emerged which I found quite interesting and clarifying.

20 years ago, Harris Corp was about $25. By the turn of the millennium it had halved in value. Then its started to rise and peaked at $60 just before the crisis. It halved again in Q1 2009 as equity indices tanked. Its journey upwards re-started steadily at first but furiously from 2016 onwards till it hit its all-time peak at 170 in April 2018.

In 2015, it acquired Exelis for about $4.6 billion. Exelis operated in the Defence / Aerospace industry and was a part of ITT group.

What does Harris Corp do?

On its website, Harris describes itself as:

‘’From ocean to orbit and everywhere in between, Harris solutions connect, inform and protect the world.’’

Harris’s roots are 125 years old. They have been around a long time and have science, technology and innovation in their DNA. They have a vast range of products and solutions for military, aerospace, space exploration, environment and other areas. In their own words:

‘’Harris is a proven leader in tactical communications, geospatial systems and services, air traffic management, environmental solutions, avionics and electronic warfare, and space and intelligence.’’

They operate via 3 segments: Communications, Electronics, Space & Intelligence. They support government and commercial customers in almost 100 countries. Their product, services and business credential is impressive and their pedigree inspiring.

A decade of volatile performance

Impressive as their business portfolio is, Harris Corp’s financial performance headline numbers are very revealing though and give a prospective investor some reasons for caution. I had a look at headline GAAP performance numbers taken for the last 10 years from Morningstar website to shed light on this company. What do I see?

Over 2008-17, Sales has compounded at 2.8%, Net income at 2.5% and diluted EPS at 3.5%. Worse, free cash flow has grown over those year at 1.2%. However dividend has risen at an impressive 15%.

  • Tepid growth in top-line, bottom-line, earnings and free cash; nothing very exciting here when viewed as a longer trend.
  • High variability in performance, for profit, earning and cash. Worrying. These numbers don’t lend themselves to reliable predictability. See for yourself.

The above makes for a risky company from a financial performance point of view.

Balance Sheet has issues

As at 31 March, 2018, Harris’s balance sheet was $10.1 billion strong of which 5.4 billion was Goodwill alone. That’s 53% of the balance sheet. As of that wasn’t enough, other Intangibles are another 1 billion. Thus, goodwill plus intangibles make up 64% of balance sheet. Now here is the thing to watch out for.

While other intangibles are amortised on a straight-line basis every year, Goodwill is not. Its kept in the balance sheet as an ‘’asset’’ and subjected to Impairment tests at least at every reporting date. If no impairment is detected it is retained at carrying cost. The risk is in economic downturns, enormous impairments can be debited to P&L.

Debt is another issue. However, that seems to be slowly managed down.

Is Harris Corp a buy?

Harris Corp has an attractive and promising business portfolio incorporating science, technology, research and innovation. Its business is also spread over a number of sectors and countries and has potential for growth given its penetration in defence, aerospace, surveillance, space, weather and so on. Despite that, Harris’s financial performance has been volatile and unpredictable making it a risky bet for a retail investor. While dividend yield is ordinary, dividend growth is notable.

As stated earlier, at 26 PE (based on 2018 EPS guidance on GAAP basis), I consider Harris expensive. Its 5 year expected PEG ratio is about 1 per Yahoo but how reliable is that given this company’s numbers have not been easy to trend? Will a clear performance trend emerge in future? Will growth in headline numbers be strong and sustained? Until that is steadily visible a 5year PEG ratio is not very credible for Harris.

I would like to see the Net Debt to EBITDA ratio fall to 2 and its PE multiple fall to 20 to give me the margin of safety and comfort that I need to be able to invest in Harris Corp. This is not impossible. After all we have seen a stock as sturdy as MMM fall from 260 to below 200 in just 3 months!

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

Additional disclosure: I am not an investment advisor. Do your own due diligence.