The Defense Industry: A First Glance – L-3 Communications Is The Leader In The Clubhouse

This is the first of several reports on the aerospace/defense industry.  Our goal is to find the stock with the most attractive risk/return characteristics. We have begun our review of 5 of the 25 companies in this industry.  There is quite a bit more work to be done, but so far the “leader in the clubhouse”, is L-3 Communications.

The aerospace/defense industry is an ideal place for a value investor to begin searching for inexpensive stocks.  As two wars grind to a conclusion, and the threat of a budget sequester has materialized, it is hard to imagine an industry where expectations could be any lower.  Many of the stocks are selling at low multiples of cash flow and book value.  It is exactly this type of “negative environment” that value investors must relish examining if they want to find real values.

Let’s get started by taking the first steps on a long journey.

The table below will help us choose where to get started.

5-year 5-year Mkt. Price/ Wall
COMPANY price high low Cap. Book Street
AAR Corp. AIR 18 67 78 700 .8 4-1-1
Aerovironment AVAV 19 40 18 400 1.4 2-11-0
Alliant Tech ATX 74 113 45   2,500 2.0 3-7-3
Anaren ANEN 23 24 9      300 1.8 4-0-0
Boeing BA 91 91 30 69,000 11.8 21-4-1
Cubic CUB 42 56 21 1100 1.7 3-3-0
Digital Globe DGI 28 33 12   2,000 2.5 6-4-1
Engility EGL 24 24 14 400 1-1 0-2-0
Excelis XLS 11 13 9 2,000 2.0 1-5-0
Gencorp GY 13 13 2 800 n.a. 2-0-0
General Dynam. GD 74 93 38 26,000 2.3 14-6-2
Harris HRS 45 63 28 5,000 2.7 1-8-2
Huntington Ing. HII 52 54 24 2,600 3.9 4-8-1
Kratos KTOS 5 21 4 280 .5 5-2-0
L-3 Comm. LLL 81 112 60 7,200 1.3 1-11-3
Lockheed Martin LMT 99 116 63 31,600 n.a. 5-17-1
Mercury Sys. MRCY 8 21 3 260 .7 3-3-1
Northrup Grum NOC 76 76 36 17.8 1.9 2-17-3
Oskosh Corp. OSK 37 43 6 3,200 1.9 9-6-0
Raytheon RTN 62 65 34 20,000 2.5 7-14-2
Rockwell Collins COL 62 67 28 8,500 7.1 10-9-2
Transdigm TDG 147 153 29 7,600 6.2 11-5-0
Textron TXT 25 62 4 6,900 2.3 11-3-0
United Technol. UTX 91 96 40 83,000 3.2 20-5-0

 

A few numbers jump off the page.  First is the extremely negative Wall Street sentiment on L-3 Communications and Northrup Grumman.  To better understand why we view this as such a positive please read, WHY WE SO LITTLE RESPECT FOR WALL STREET BUY/SELL RECOMMENDATIONS. The second point of interest is a few of the stocks selling at low multiple of book value. To better understand why this is important see, WHY PRICE/BOOK VALUE IS A GOOD STARTING POINT.  Third, we see several stocks selling close to their lows and well off their highs. See, BUY LOW, SELL HIGH

The complete results of our 1-hour analyses are presented here:

See, HOW TO DO A 1-HOUR ANALYSIS

LLL   1-hour analysis

NOC 1-hour analysis

AAR   1-hour analysis

AVAV 1-hour analysis

KTOS 1-hour analysis

Initial Conclusion

LLL is the most interesting of the five stocks we reviewed.  The company is exposed to a wide variety of programs that seem to remain critical even as the U.S. war efforts wind down.  More importantly, LLL seems to have a culture of good financial decision making that will be important as the industry consolidates.  NOC also has interesting attributes, but we fear its strong balance sheet might tempt it to make an acquisition, AIR is interesting because it has more exposure to commercial aircraft, but the company also was the most directly involved in the Mideast wars.  AIR has also messed up its balance sheet, so we can only watch for now.  AVAV and KTOS have attractive valuations, but we are not sure we really understand them just yet.  AVAV has plenty of cash, and no debt, but its investment in electric car infrastructure will take a while to understand. KTOS is essentially a private equity investment. It will most likely be too leveraged for our tastes, but will be a very worthwhile company to study.

Next Steps

We have just begun our investigation into the aerospace/defense industry.  Our goal is to find the stock with the best risk/return trade-off.  We will continue to research each of these 5 companies, but our initial emphasis will be on LLL. We will also investigate another 5 companies. Your questions and comments are welcomed. Stay tuned.

 

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