L3Harris Technologies Inc. (NYSE: LHX). We expect Harris to benefit from the substantial increase in military spending over the past few years, and look for solid earnings growth in 2020-2021 and subsequent years. We think the acquisition of L3 Technologies makes sense and offers another channel for growth. Management is focused on shareholder returns and has boosted the dividend twice in the past year, signaling confidence in its outlook. The shares trade at a premium to the group, which we believe is warranted given our expectations for above-industry-average growth, as well as the company’s strong long-term track record.
The beta on LHX shares is 0.75.
L3Harris recently reported 3Q20 non-GAAP EPS that increased 10% year-over-year and topped expectations. On October 30, HRS reported that 3Q revenue rose 4% year-over-year on a pro-forma basis, to $4.5 billion. The EBIT margin widened by 60 basis points to 17.9%.
The severe decline in global air traffic has significantly reduced demand for L3Harris’ flight training, flight simulators and commercial avionics products.
In May, Harris sold its Security Detection and Automation businesses to Leidos for $1 billion. Management estimates that 8%-10% of revenue will ultimately be divested, with one-third of the program already completed.
EARNINGS & GROWTH ANALYSIS
L3Harris has four business segments: Integrated Mission Systems (IMS, 31% of sales), Space & Airborne Systems (SAS, 27%), Communication Systems (24%), and Aviation Systems (18%).
Three of four segments reported an increase in revenue in 3Q. Integrated Mission Systems sales rose 6% on growth in the maritime business and classified platforms. Space & Airborne Systems increased 7%, driven by F-35 modernization in avionics as well as by higher sales of classified intel and cyber products. Communication systems rose 7% due to strong demand in overseas markets. But Aviation Systems revenue fell 4% due to a slowdown in Commercial Aviation Solutions. Looking ahead, we expect mid-single digit growth in IMS, SAS and CS, and a low-single-digit decline at AS.
FINANCIAL STRENGTH & DIVIDEND
Harris pays a dividend. This was the company’s second double-digit dividend increase within a year, and marks the 18th consecutive year that Harris has raised its dividend. Based on our expectations for continued growth in the company’s businesses and solid cash flow, we look for further increases in the payout.
MANAGEMENT & RISKS
William Brown has been the company’s president and CEO since 2011, and its chairman since 2014. Prior to Harris, CEO Brown held a range of management positions at United Technologies. Jay Malave is the new CFO. He was previously CFO of the Carrier division of United Technologies.
The company has been fine-tuning its portfolio over the years. Management is now focused on integrating L3 Technologies. L3 was acquired in June 2019 in an all-stock merger of equals that valued L3 at $15 billion. In April 2017, Harris sold its government information technology business to a unit of Veritas Capital Management for $646 million. In January 2017, HRS sold its Harris CapRock Communications commercial business to SpeedCast International for net proceeds of $370 million. Both sales represented a strategic shift away from noncore markets (such as energy, maritime and government IT), in keeping with management’s efforts to simplify the company’s operating model and focus on high-margin businesses.
The sales of the IT services business and Harris CapRock were driven in part by an agreement with activist investor Jana Partners, which had previously taken a 1.9% stake in Harris. The company also agreed to appoint two new board members, James Albaugh and Roger Fradin, nominated by Jana. Mr. Fradin continues to serve on the board even after Jana sold its remaining stake in Harris in March 2017.
Even with the pandemic, the company is on track to exceed these targets and timing dates.
The company also faces risks, including currency risks, in its overseas operations. Harris is a global company. Operating in over 100 countries, the company derives approximately 20% of revenue from overseas markets. HRS could face uncertain results during periods of global economic weakness and/or geopolitical conflict. It could also be hurt by poor results from acquired companies.
The company has 48,000 employees.
The shares are a bit above average on price/sales and a bit below average on yield, signaling a modest premium to the industry.
On march 29, BUY-rated LHX closed at $202.90, up $3.96.