Why Raytheon shares are poised to surge

The company is gaining momentum from foreign-contract wins, a stabilized US defense budget and falling pension costs.

By MSN Money Partner Apr 28, 2014 5:09PM
U.S. Navy guided-missile destroyer USS Barry (DDG 52) launches a Tomahawk cruise missile in support of Operation Odyssey Dawn March 29, 2011 from the Mediterranean (© U.S. Navy via Getty Images)By Sandra Ward, The Wall Street Journal

Amid rising global tensions and burgeoning interest in cybersecurity, defense-electronics and missile-systems contractor Raytheon (RTN) is set for another big year.

A string of high-margin foreign-contract wins and prospects for more, a stabilized U.S. defense budget, falling pension costs and strong cash flow add up to a stock poised to move higher. Already this year, the Waltham, Mass., company has rewarded shareholders by lifting its dividend 10 percent and continuing to buy back shares.

A rise in the stock price of 20 percent is within reach, and 30 percent, possible, thanks to higher profits and margins. With earnings exceeding expectations in each of the past eight quarters and projections that are being revised steadily higher, it's only a matter of time before the stock fetches a higher price/earnings multiple. Some analysts see earnings approaching $10 a share by 2016. That compares with $5.96 for 2013.

On Thursday, Raytheon reported a 21 percent year-on-year rise in first-quarter profit, beating forecasts. But it also left its full-year guidance unchanged, disappointing investors, who sent the shares plunging by 5 percent to around $95. The stock closed Monday at $

At that price, Raytheon shares trade for about 12 times projected 2015 earnings, one of the lowest valuations among the prime defense contractors, including General Dynamics (GD) and Lockheed Martin (LMT), because, some say, it lacks the legacy programs of those peers.

Yet, "it's arguably the most profitable" of its peers, argues Scott Lawson, a defense-stock analyst at Westwood Management in Dallas, which owns the shares.

Lawson finds the stock compellingly priced, especially given that 2014 likely represents a trough in the revenue cycle for defense contractors.

He notes that on a P/E basis, Raytheon historically commanded a 10 percent to 20 percent premium to the S&P 500 index, but now trades at about a 5 percent discount. Moreover, its dividend provides an above-market 2.5 percent yield.

If Congress resolves the uncertainty created by automatic budget cuts, or sequestration, stemming from the 2011 Budget Control Act by reaching a broader fiscal pact, that would be another plus for Raytheon.

RBC Capital Markets defense analyst Robert Stallard values the stock at $126 if the P/E multiple expands to 15 times earnings from current levels. At the very least, the bipartisan budget deal reached late last year assures stability for the next two fiscal years.

As core earnings tick higher, Raytheon will get an additional boost from pension reimbursements, a result of accounting rules related to defense contractors reconciling past overpayments. What was a drag on expenses now enhances income: Raytheon expects pension reimbursements to add $346 million to net income this year. It expects net pension-related gains of $776 million in 2015 and $1.3 billion in 2016.

More from The Wall Street Journal


Apr 29, 2014 11:36AM
peace?  we don't need no stinkin' peace!
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