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L3 Communications: Value Play or Value Trap?

September 22, 2011 | About:
Company: L3 Communications

Ticker: LLL

Recent: $58.94

The stock holds a 4-Star GuruFocus Rating

A few weeks ago, Chuck Carnevale wrote an excellent article, 8 Strong Growth Stocks Significantly Undervalued by Mr. Market, that identified L3 Communications as a value play.

Strictly looking at their fundamentals, L3 Communications looks like a huge value play.

In the last decade they have increased their sales by more than 568% from $2.3 billion to $15.6 billion, while their net profit has gone up more than eight fold from $115 million to $955 million. Oh, and let's not forget about the Buffett indicator (a.k.a. book value), which rose from $15.46 to $62.27 at a rate of 14.45% annually. More importantly, if you had bought the stock back in 2000 and held it until today, you would have made 200% on your money with dividends and share appreciation.

Price History



Current Data



Currently, the stock is trading with a P/E multiple of 7, an all-time low for a company that historically trades around 17 times earnings. This too would signal that the company is discounted by the market; however, it could be a trap.

Here's why.

First, past profits and book value growth do not predict the future. Look at a company like Blockbuster Video, who had a long history of growth and then within five years claimed bankruptcy. This is not likely to happen in the case of L3, yet we are in a changing political environment where it is no longer fashionable, to the public, to be at war.

This is a big concern considering L3’s main customers include the U.S. Department of Defense (76% of sales) and its prime contractors, U.S. Government intelligence agencies, the U.S. Department of Homeland Security, U.S. Department of State, U.S. Department of Justice, allied foreign governments, domestic and foreign commercial customers and select other U.S. federal, state and local government agencies.

Secondly, if you haven't been keeping up with the news, as a country, we're broke! According to http://www.usdebtclock.org the total unfunded liabilities come to over $1 million per taxpayer. I really doubt that we will be able to afford to keep the huge defense budget going forward.

As for L3 Communications, the company now faces the challenge of increasing cash flows and earnings in the face of spending cuts and recent program losses. We will not be spending the same $500 billion a year throughout the next decade and that will be very challenging for LLL, as the company has not carved a large enough economic moat to sustain its growth in my opinion.

It's sad for me, because when I first look at company like this (i.e., low P/E, solid growth, at 52-week low), I get very excited, but when I start thinking about it, I realize that it probably deserves to be in my "no-go" stock pile. Maybe I'll be wrong, but it's better to say "no" to a good deal than "yes" to a bad one.

Obviously, if you believe in the Pabrai approach, then even LLL will be a good buy at a certain price, but that could be 50% lower than its current quote. Maybe for long-term buy and hold investor, owning the stock at these levels might make sense? For all we know, the market could decide that L3 is worth a 15 price multiple over the next few years. Crazier things have happened — Netflix (NFLX) with 100 P/E or Salesforce (CRM) with 500 P/E — come to mind, so it could easily double based on that alone.

The question you have to ask is: How likely is that? What is more likely is that they cut estimates and the stock drops or flat lines and doesn’t get back to the Joel Greenblatt price levels of $80 per share it saw a few months ago, at least not for some time. So, while the consensus of 15 leading analysts reporting to Zacks expects L-3 Communications Holdings Inc. to continue to grow earnings over the next five years at 8.3% per annum, I have to disagree with them on this one.

About the author

Jonathan Poland is the publisher of The Poland Report, premium investment newsletter and portfolio management system designed to help individual investors manage their money more effectively. Since 2002 his research has outperformed the market by more than 15 to 1. He has written for GuruFocus.com since 2008 and was instrumental in helping the website develop its own value newsletter services. As a former stockbroker, Mr. Poland feels that most investors would benefit from a do-it-yourself approach foregoing full service money management in lieu of lower costs and better performance. Visit The Poland Report.

About the author:

Jonathan Poland
Since 2002, I've worked with investors all over the world. Between 2009 and 2010 worked with GuruFocus to start their investment newsletter service.

Visit Jonathan Poland's Website


Rating: 2.7/5 (13 votes)

Comments

pravchaw
Pravchaw premium member - 2 years ago
LLL is still growing eps - though I agree macro environment for this firm is challenging. It would be attactive at below $45.

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