Argus Upgrades Raytheon, Lifts Northrop Estimates

• The share price of Raytheon Company RTN has appreciated 10.99 percent over the past six months, while that of Northrop Grumman Corporation NOC has appreciated 16.86 percent over the same time frame.
• Argus’ John Eade has upgraded the rating on Raytheon from Hold to Buy, with a price target of $135, while maintaining a Buy rating on Northrop Grumman but raising the price target from $195 to $205.
• Both stocks have outperformed over the last quarter, with both companies reporting their Q3 results above the consensus expectations.

Beat & Raise

Analyst John Eade mentioned that Raytheon appeared optimistic regarding the 2016 sales trends. Eade expects “management’s focus on international and cybersecurity businesses to generate stronger growth over the next two years.”

Eade believes the company’s business mix is more favorable than most of its defense industry peers, “given rising geopolitical threats, we like its emphasis on advanced missile defense, electronic warfare and cybersecurity systems.”

Raytheon has also been generating robust cash flow, while returning cash aggressively to shareholders via higher dividends and share buybacks.

For Q3, the company reported a 6 percent increase in net sales, although EPS declined 10 percent, driven by dilution from the Q2 cybersecurity joint venture with Websense Inc WBSN. However, the EPS still beat the consensus.

Total booking for the quarter were below the 3Q14 levels, while international revenue grew 13 percent year-on-year and accounted for 32 percent of the total revenue.

Management also raised its sales guidance for 2015, while maintaining its guidance for EPS from continuing operations.

“CEO Thomas A. Kennedy said that the company expected “a strong finish to the year” and was poised for solid top-line growth in 2016. Raytheon sees a potential increase in demand for its products as foreign governments respond to increased global threats,” the Argus report said.

Estimate Raised

“On October 27, Northrop was selected by the U.S. Air Force as its partner on the Long-Range Strike Bomber. This program is expected to result in 80-100 bombers, at a cost of $500-$550 million each, over the next 15-20 years,” Eade reported.

For Q3, Northrop Grumman reported flat year-on-year revenue, while net earnings rose 9 percent, driven by widening margins. The adjusted EPS came in above the consensus, with 22 percent year on year growth, driven by share buybacks.

The company has raised its EPS guidance for 2015, while marginally raising the low end of the revenue guidance.

Eade noted that the company is significantly dependent on defense spending, with 85 percent of its 2014 revenues coming from the U.S. government. “Recent budget trends have been generally supportive for the industry,” Eade further mentioned.

While defense spending has increase 4.5 percent in 2015, the Department of Defense expects for an additional increase of 2 percent through 2020.

“The company’s balance sheet is clean, and management has a history of meeting and beating analyst expectations,” the report said, while adding, “Management is aggressively repurchasing stock, with a clear focus on delivering returns to shareholders.”

The EPS estimate for 2015 has been raised from $9.70 to $9.85.