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Dividend Analysis of Aerospace and Defense Stocks

June 24, 2014 | About:
Vinay Singh

Vinay Singh

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For this article, I've researched dividend-paying companies in the Aerospace/Defense Industry. Also, to make sure I find the best gems, all three stocks mentioned in this article comply with the following criteria:

  • Market Cap of more than $500 million and an average volume of at least 300K
  • Beta of less than 1 = Low Volatility
  • DCF valuation discount of at least 20% = Earnings translating into cash flow
  • Cash per share and Current Ratio greater than 1.5 = Good Liquidity = Dividend Sustainability
  • Dividend Yield of at least 2.5% = Obvious

Sturm, Ruger & Co. (RGR)

The company is engaged in the manufacture and sale of firearms in the United States.

It has $1.61 per share in cash, no debt and an expected EPS growth for the next 5 years of 11%. Analysts expect $3.8 in EPS for fiscal year 2013, and the current stock price is only 14.7 times that figure, compared to its peer average of 17 times.

It has an impressive EBITDA margin in the mid 20s and operating cash flow margin in the high teens. This has helped it generate impressive levels of free cash flows in recent years, and even when I look at the enterprise value implied by the current stock price, it's only 8.3 times trailing EBITDA.

With a free cash flow margin around 10%, the company should be able to further increase its cash reserve by $2.50 per share next year. ** This will increase total cash to more than $4 per share! It's no wonder the company issued a special dividend of $4.50 per share late last year, in addition to regular dividends.

Its quarterly dividend varies because the company pays a percentage of earnings, rather than a fixed dollar amount per share. The current quarterly dividend of $0.40 per share is approximately 40% of the net income. For all of 2012, it returned $111.5 million to shareholders through the payment of dividends.

I'm comfortable with a long-term revenue growth outlook of high single-digits on Sturm, Ruger. In the wake of recent scrutiny over firearm sales, some might call this estimate too high. That doesn't bother me, and I'd only offer the following rebuttal - the market has always been a forward-looking entity willing to look past near-term troubles.

The aforesaid sales growth rate would speak to a potential long-term free cash flow growth rate in the mid-to-high teens, if not even higher. Discounting that back, it suggests a fair value of about $73.

L-3 Communications Holdings (LLL)

The company provides various security solutions in the United States and internationally.

It has $3.75 per share in cash and enough short-term receivables to take care of its entire long-term debt. Analysts expect $8.34 in EPS for the next fiscal year, and the current stock price is only 9 times that figure, compared to a peer average of 17 times, suggesting L-3 Communications is significantly undervalued.

Impressively, it has similar margins on both EBITDA and operating cash flow in the low double-digits, and its enterprise value implied by the current stock price is only 6.6 times trailing EBITDA. With a free cash flow margin of around 10%, the company should be able to further increase its cash reserve by $14.25 per share next year. **

Also, the company recently raised its quarterly dividend by 10% and authorized the repurchase of as much as $1.5 billion of its stock in a bid to boost shareholder returns. It's no wonder the share count has fallen from 122 million in fiscal 2008 to 94 million at the end of 2012, and considering the management's plans on buybacks, this trend should continue.

Long-term sales growth is where the estimates get tricky. The company faces revenue declines from the winding down of operations in Iraq and Afghanistan, and defense spending cuts due to the rising focus on deficit reduction.

Nevertheless, I expect a steady improvement in free cash flow generation. All told, I think L-3 Communications can grow its free cash flow at a 2-4% rate for the long-term. Discounting that back, it suggests a fair value of about $95.

Raytheon (RTN)

This company also provides various security solutions in the United States and internationally.

It has $12.39 per share in cash and a current ratio of 1.57; the company is liquid. Analysts expect $5.44 in EPS for the next fiscal year, and the current stock price is less than 10 times that figure, compared to a peer average of 17 times, suggesting Raytheon is significantly undervalued.

It has an impressive EBITDA margin in the mid-teens and an operating cash flow margin in the mid single digits. It reported strong operating cash flow from continuing operations at $1.0 billion in the fourth quarter and $2.0 billion for the entire year.

Backed by the strong free cash flow, the company should be able to further increase its cash reserve by $7.5 per share next year. ** Also, the share count has fallen from 425 million in fiscal 2008 to less than 330 million at the end of 2012, and considering the management's plans on buybacks, this trend should continue.

Like L-3 Communications, Raytheon faces revenue declines from defense spending cuts. Nevertheless, I think Raytheon can grow its free cash flow at a 2-5% rate for the long-term. Discounting that back, it suggests a fair value of about $66.

The bottom line

To generate safe and stable income in a volatile market environment, investors should diversify their portfolios with different industries. With impressive cash flows and dividend yields of more than 2.5%, the aforesaid stocks in the Aerospace/Defense Industry offer investors a valuable source of regular income, as well as the potential for long-term capital appreciation.


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