We maintain our ‘Neutral’ recommendation on L-3 Communications Holdings Inc. (LLL) reflecting our concerns regarding the loss of key contracts, a backlog skewed toward fixed price contracts and possibilities of cuts in future defense budgets. L-3 Communications also holds a Zacks #3 Rank, which translates into a short-term Hold rating, and correlates with our long-term recommendation.
We however believe that L-3 Communications by virtue of its non-platform focus, prominent position as sub-contractor/supplier to other defense primes, broad diversification of programs, and strong order bookings stands out among other pure defense players. Its strong balance sheet also provides financial flexibility to increase its dividend, indulge in share repurchases and earnings accretive acquisitions. In 2010, the company acquired four companies, which extended its product line, raised its expertise in niche fields, and expanded its reach to customers with specialized needs in the defense industry.
L-3 Communications’ first quarter EPS of $1.85 comfortably surpassed the Zacks Consensus Estimate of $1.78. Quarterly net sales fell marginally by 1% or $23 million year-over-year to $3.6 billion and came in line with the Zacks Consensus Estimate.
Lower sales year over year primarily came from the Aircraft Modernization and Maintenance (AM&M) and Electronic Systems segments. AM&M sales were lower primarily due to the loss of a Special Operations Forces Support Activity (SOFSA) contract, while Electronic Systems sales were offset by lower volumes. The downside was partially offset by higher sales from the Command, Control, Communications, Intelligence, Surveillance and Reconnaissance (C3ISR), and Government Services segments.
A substantial portion of L-3 Communications’ business is generated within the U.S, with government and commercial sales accounting for 87% of sales in fiscal 2010. Budget deficits and political uncertainty looms on future defense budgets with high chances of shrinkage. Moreover, more than half of L-3 Communications’ sales in fiscal 2010 came from fixed priced contracts. Consequently, the company will only be able to make a profit if costs stay within the set limits. Given these headwinds, we maintain our neutral stance on L-3 Communications.
L-3 Communications operates through its wholly owned subsidiary, L-3 Communications Corporation. The company is a leading supplier of a broad range of products and services used in a number of aerospace and defense platforms. It competes with Honeywell International Inc. (HON), and Raytheon Company (RTN).
HONEYWELL INTL (HON): Free Stock Analysis Report
L-3 COMM HLDGS (LLL): Free Stock Analysis Report
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