L-3 Targets a Brave New World

10/22/2004 12:00 am EST

Focus:

Gregory Spear

Editor and President, The Spear Report

"Sadly, security is a growth industry and it is likely to be that way for years to come," says Gregory Spear. "We have found an impressive way to play this trend, with L-3. This is a ‘Brave New Economy’ stock, or a beneficiary of a global village under siege."

"L3 Communications (LLL NYSE) gets about 90% of its revenue from foreign and domestic government-related business. Companies such as L-3 that depends on government contracts often sell at a discount to market multiples because of the unpredictable nature of politics and policies. Further, many companies in the defense sector have such highly specialized areas of expertise that they become dependent on winning specific large contracts, and this makes them additionally vulnerable.

"It is rare to find a company whose major objective is to support other prime defense contractors in a broad array of products and services, in addition to developing its own commercial business. This approach gives L-3 a unique level of diversification that has enabled the company to maintain steady growth, year after year.  Its Intelligence, Surveillance and Reconnaissance unit supplies advanced airborne and ground-based communications systems that detect, collect, identify, analyze and disseminate information. L-3 also provides training for flight crews, simulation tools, democracy transition and leadership development, and crisis management software for homeland security applications. Its aviation segment provides air traffic collision avoidance systems for both commercial and military aircraft.

"L3 also offers cargo, vehicle and passenger screening, surveillance systems, intrusion detection radar, and advanced navigation products. The s ecurity and detection unit has an installed base of over 18,000 systems worldwide, and offers screening technologies for numerous security applications that include: 1) aviation systems for baggage explosives detection 2) cargo and air freight screening, 3) port and border inspection, 4) and facility protection. Their newest cargo screening vehicle, the CX3800M, has a throughput of over 20 trucks per hour and is capable of imaging the contents of a fully loaded, 18-wheeled tractor-trailer or 40 ft. cargo container - through 10 inches of steel.

"L-3 has an unusually consistent and strong record of sales and earnings growth over the last few years, both above 30%. Earnings per share were up 42% in the first half of 2004. L-3 has a target of 20% annual growth. As of June 30, 2004, L-3 had $228 million in cash, an increase of $93 million year over year, while reducing debt. Technically, the stock is at all-time highs and this makes it somewhat vulnerable to profit taking. We expect a pause here and then new highs later in the year. The company is in the sweet spot in terms of market capitalization, so that significant growth in share price is possible. A 20% grower in all economic environments deserves a premium valuation, so we should see p/e expansion, as well.

"The US military is undergoing a rapid technological transformation as it attempts to integrate recent advances in electronics and information technology. Simply put, L-3 offers an amazing variety of products and services that facilitate this transformation. If you want a play on homeland security as well as the new electronic battlefield, advanced surveillance, Unmanned Aerial Vehicles (UAVs), cargo, passenger and vehicle inspection, crisis management systems, etc, etc, L-3 has it all."

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