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AmextaFinance > Investing > Buy L3Harris Stock. Shares Could Be Set for Big Gains.
Investing

Buy L3Harris Stock. Shares Could Be Set for Big Gains.

News Room
Last updated: 2024/02/15 at 10:14 PM
By News Room
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A scarier world hasn’t made winners out of military stocks lately. Shares of
L3Harris
Technologies, however, look as if they can buck that trend with a mix of sales growth, margin expansion—and a nudge from an outside investor.

L3Harris isn’t a household name like
Lockheed Martin
or
Northrop Grumman.
It is big, though. With a market value of some $40 billion, it’s the sixth-largest U.S. military contractor, behind the two giants and
RTX,

Boeing,
and
General Dynamics.
It doesn’t assemble stealth bombers like Northrop or make jet fighters like Lockheed. Instead, L3Harris sells a lot of advanced tech serving land, sea, and air operations. Its Integrated Missions Systems unit makes radar warning systems for jet fighters and avionics for commercial aircraft, among other products. Avionics are electronics on planes that govern functions such as navigation. Its Space & Airborne Systems group can build satellites. A communications business sells products such as radios for the army. Its acquisition of Aerojet Rocketdyne in July 2023 gave L3Harris a fourth business, making rocket engines.

The stock has fallen on hard times of late. Since CEO Chris Kubasik took over in 2021, L3Harris shares have returned just 1%, including reinvested dividends, trailing the
S&P 500 index’s
21% return over the same period. That stands in contrast to the performance under Kubasik’s predecessor, Bill Brown, when shares grew almost fivefold. Sales have continued to grow, but inflation and fixed-price contracts have squeezed profit margins for the entire sector. 

That’s one reason activist investor D.E. Shaw took a position in L3Harris stock. D.E. Shaw didn’t return a request for comment about the reasons for its initial involvement, but the fund and the company announced an agreement on Dec. 11. Shaw got two board representatives—Kirk Hachigian and Bill Swanson—while the company undertakes a business review led by former CEO Brown. It’s all designed to improve performance compared with recent years. 

“It’s not often that you see an ex-CEO agree to consult his former company on a project like this,” says Gordon Haskett special situations analyst Don Bilson, who writes about topics including shareholder activism. “When [Brown] left the company in 2021, L3Harris traded with a higher forward EPS multiple than Northrop and Lockheed. It now trades at a discount.”

He has a point. L3Harris trades for about 16 times estimated 2024 earnings, not only below the S&P 500’s 20 times but also lower than Northrop’s 18.1 times and Lockheed’s 16.4 times. 

L3Harris could be worth much more. One day after announcing its agreement with D.E. Shaw, the company hosted an analyst day, when it laid out financial goals for coming years. Management expects sales to hit $23 billion in 2026, up from $19.4 billion in 2023, while generating an operating profit margin of 16%, up from just under 15%. L3Harris also highlighted Increasing software-based sales and plans to take out $1 billion in costs over the next three years. 

“You’ve got a much greater sense of urgency on [Kubasik] and upper management to deliver margin expansion and get to the financial targets,” says RBC Capital Markets analyst Ken Herbert, who has a $245 price target on the Buy-rated stock, up about 17% from Wednesday’s close of $210.18. 

There are some early signs of improvement. L3Harris reported better-than-expected fourth-quarter earnings on Jan. 25. Management gave financial guidance for 2024 that bracketed Wall Street’s expectations. Operating profit margins are expected to come in at about 15%, up from 2023’s 14.8%.

Vertical Research Partners analyst Rob Stallard called the guidance “conservative,” while noting the “real work lies ahead.” He rates the stock Buy and has a $240 price target on it, up 14%.

RBC’s Herbert is valuing L3Harris stock at about 17 times his 2025 earnings estimate, but its valuation could head even higher if the company hits its goal of about 14% earnings growth annually for the next three years. That kind of growth would justify a market multiple of 20 times, a level that the stock was trading at less than two years ago. Trading at 20 times 2025 consensus earnings estimates puts L3Harris stock at $280, up 33% from recent levels.

Don’t make the mistake of assuming that L3Harris is worth buying just because wars have broken out around the globe. Yes, the war in Ukraine grinds on, along with fighting in the Middle East. Tensions between China and the U.S. and Taiwan are also on the rise. Yet shares of the five largest U.S. contractors—excluding Boeing, which has 737 MAX issues to contend with—are down about 3% on average over the past 12 months. None trades for a market multiple. 

“Defense stocks go up when there is a military event, but further gains tend to need a follow-through of U.S. involvement and more defense spending,” says Vertical’s Stallard. “This is partially why Ukraine and Gaza are not continuing to help defense sentiment, as the trajectory of funding both these conflicts appears to be heading down.” 

There is also the health of the sector’s best customer, the U.S. government. Since the end of 2018, the cumulative federal budget deficit has totaled roughly $10 trillion, and the math makes investors believe that—eventually—it will put pressure on the U.S. military budget. 

Thankfully, L3Harris has plenty of idiosyncratic drivers to boost its stock. In its case, fixing what’s broken could be the best defense. 

Write to Al Root at allen.root@dowjones.com

Read the full article here

News Room February 15, 2024 February 15, 2024
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