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The Real Story Behind Raytheon's Earnings? Cash


Investors seem to have forgotten about the government's woes, and now Raytheon has given them good reason to be optimistic about the future.


Raytheon (RTN) beat analyst estimates both in earnings and revenues, causing the stock price to climb above the $50 mark in premarket trading.

Expectations have remained high for the company, with the stock climbing steadily from a sharp drop in summer caused by disappointing earnings that seemed further threatening by the S&P downgrade of US sovereign debt and worries that the company could lose government contracts.

Investors seem to have forgotten about the government's woes, and now Raytheon has given them good reason to be optimistic about the future, thanks in no small part to its 12% jump in earnings.

For the last quarter, adjusted earnings per share climbed to $1.58, beating estimates by $0.24 thanks to improvements in the company's operations that offset analyst expectations that lowered defense spending by American agencies would hit the company's bottom line.
While it is true that the results reflect a quarter-on-quarter jump in earnings of 17% and a year-on-year jump of 15.3%, investors need to remember that even some Republicans have been eyeing the US defense budget as a place to cut corners, which will ultimately hurt defense contractors before anyone else.

Raytheon has been moving into international markets for just this reason. In 2011, the company booked $782 million thanks to a contract to work on radars for the Saudi Arabian air force and $560 million from contracts with Taiwan. Over 35% of the revenue from the company's Integrated Defense Systems operations came from international customers.

While international expansion is to be expected from companies nowadays, for defense companies like Raytheon, the international market is limited. The company cannot sell freely to any market in the world; while most companies can always cite China as a potential growth market, this is not possible for Raytheon. While the company has secured some contracts in the Asian giant in the past, obvious political considerations would make it impossible for the company to sell its missile-tracking or cybersecurity services to the Chinese.

With international growth limited, Raytheon remains dependent on the Department of Defense, and the company still retains a number of contracts with the American government. It will need to keep those contracts to maintain its revenue, and it can only do that by focusing on the right things.

Fortunately, Raytheon has already recognized the growth markets in defense contracting. The company saw particularly growth in its Applied Signal Technology and Intelligence, Surveillance, and Reconnaissance systems programs.

With drones and cyberwarfare hot topics both among geopolitical experts and nongovernmental organizations, a jump in these operations is to be expected, and Raytheon would be wise to invest more in these products if it wants to continue to see revenue growth as the Department of Defense tightens its belt.

On the cost side of things, the company was hit by pension costs, such as a $750 million discretionary contribution. However, pensions were not as big of a concern as some might have feared, with cash contributions to the company's pension plans actually falling from 2010's figure of $1.9 billion; for 2011, that figure dropped to $1.8 billion. Quarterly costs for pensions and post-retirement benefits actually fell to $500 million for the fourth quarter (down from $559 million in the previous quarter). The company has also been able to wipe out many of its long-term liabilities.

Despite more modest costs, the company's bottom line is threatened by a fall in net sales that reflects the drop in defense spending in America. Fourth quarter 2010 saw $6.89 billion in net sales on operating expenses of $6.08 billion, but last quarter saw a 6.4% fall to $6.44 billion in net sales.
The jump in earnings is thanks to leaner operations, which cost only $5.58 billion in last quarter, for a drop of 8.2%. While a drop in operating costs can be seen as a short-term positive for the company, it should also make investors consider whether Raytheon is becoming a smaller company – which could mean smaller returns in the future.

On the other hand, we may see Raytheon expanding thanks to a jump in working capital. The company reported cash assets of $4 billion (up almost $400 million on last year) and working capital of over a billion, up a staggering 118% percent from third quarter 2010. While working capital is down for the year, this jump in recent months is a sign that the company's liquidity is strong.

Cash flow is particularly important for dividend payouts, which is a major draw for the company. At a 3.4% dividend yield, the company has been a favorite for its quarterly payouts, which the company has steadily increased since 2005. While there was little chance that the dividend will begin to fall anytime soon, investors need to keep an eye on the company's cash flow as well as its bottom line.


Traders who believe that Raytheon is showing signs of strength might want to consider the following trades:

  • Buy Raytheon now and hold for the dividends and capital growth.
  • Play Raytheon as a short-term gain opportunity as investors continue to see value in the stock thanks to its push into international markets and its focus on the right kinds of defense work.
  • Invest in a defense ETF such as the Powershares Aerospace and Defense ETF (PPA). For more diversification, you could invest in a broader ETF with defense exposure, such as the Industrial Select Sector SPDR (XLI) or the Vanguard Industrials ETF (VIS). All of these funds are up for the week.
Traders who think that Raytheon may be contracting may want to think about some alternatives:
  • Short Raytheon as it jumps on earnings.
  • Look at competitors in the defense sector, such as Northrop Grumman (NOC), Kratos (KTOS), and Boeing (BA).

Editor's Note: This content was originally published on by Samuel Richter.

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