Raytheon: Blue Chip in Defense

08/15/2016 7:00 am EST

Focus: STOCKS

John Eade

President and Senior Analyst, Argus Research Group

This company’s business mix appears favorable compared to that of most defense industry peers, and given rising geopolitical threats, we like its emphasis on advanced missile defense, electronic warfare and cybersecurity systems, states John Eade, editor of Argus Research.

Our rating on Raytheon (RTN) is buy. We expect management’s focus on its international and cybersecurity businesses to generate stronger growth over the next three to five years.

The company is also generating strong cash flow and aggressively returning cash to shareholders through increased dividends and share buybacks.

RTN relies heavily on defense spending, as approximately 70% of revenue comes from the US government. Recent budget developments have been generally supportive for the defense industry.

In December 2015, Congress passed a fiscal year 2016 defense budget of $573 billion, $38 billion higher than the base recommendation and including a 15% increase in modernization funding.

Department of Defense forecasts call for additional increases of 2% through 2020. The 2016 budget includes modernizing investments in such areas as nuclear deterrence, missile defense, cyber security and power projection.

We are boosting our 2016 EPS estimate to $7.30 from $7.14, based on the company’s strong sales, tax benefits and expected margin improvement in its Integrated Defense Systems unit and its Intelligence, Information, and Services unit; the latter reflects higher cybersecurity and special mission’s revenue.

We are maintaining our 2017 forecast of $8.13, pending budget developments in Congress. Our five-year earnings growth rate forecast is 9%.

Raytheon has a buyback program. During the quarter, the company repurchased 1.6 million shares of common stock for $202 million. Thus far in 2016, it has repurchased 4.8 million shares for $602 million.

Raytheon pays a quarterly dividend of $0.7325 per share, or $2.93 annually, for a yield of about 2.1%. The dividend appears secure and we expect it to grow. We look for payouts of $2.87 in 2016 and $3.12 in 2017.

Investors in RTN shares face risks. As a key supplier to the US military, Raytheon is likely to be impacted by defense spending pressures over the next decade, especially in its short-cycle businesses.

That said, Raytheon has a diverse product base, which effectively reduces its dependence on any single platform; in fact, no single program provides more than 5% of total sales.

Our revised target price of $161, raised from $144, implies a P/E of 20-times projected 2017 earnings. While this is above the industry average, we believe that Raytheon merits a premium valuation given its strong growth outlook.

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By John Eade, Editor of Argus Research

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