To Get Growth
Play Defense With L-3

By Richard Moroney
Dow Theory Forecasts

        Growth in defense and homeland security spending is driving profits at L-3 Communications (NYSE LLL $79). Demand for secure communications, surveillance and reconnaissance systems, aircraft modernization, and security products remains strong. L-3's commercial businesses are also posting gains, helped by volume increases for security products and commercial aviation. The company has delivered impressive growth over the last five years - with annualized growth of 36% in sales and 31% in per-share profits - and healthy expansion should continue as L-3 acquires more leading suppliers in niche markets and improves internal performance. The stock, a Focus List Buy, earns an 89 Overall Quadrix" score, with 87 in Quality, 82 in Earnings Estimates, and 79 in Momentum.

Corporate Profile

        L-3 Communications supplies specialized communications systems, defense electronics, and other products. The company operates four divisions: specialized products (25% of 2004 revenue); secure communications and intelligence, surveillance, reconnaissance (24%); aviation products and aircraft modernization (33%); and training, simulation, and support services (18%). The specialized-products, aviation-products, and training-services segments delivered strong June-quarter results, with respective sales gains of 47%, 24%, and 20%. The secure-communications unit posted 4% sales growth, hurt by volume declines for secure telephone equipment.
        The U.S. government accounted for 80% of 2004 revenue. Commercial customers represented 12% of sales, while foreign governments generated 8%. Government demand for L-3's electronics products is rising as military strategies shift from traditional combat to high-tech fighting methods. Because L-3 also caters to the operating and maintenance needs of the military, it generates steadier revenue growth than defense contractors with businesses strictly focused on military procurement and research and development.
        In July, L-3 acquired Titan, a provider of government information and communications systems, for $2.65 billion in cash and assumed debt - L-3's largest acquisition to date. The acquisition should diversify L-3's revenue stream and broaden its offerings. Titan generated revenue of $2.05 billion in 2004.
        While much of L-3's growth comes from acquisitions, management is placing greater emphasis on internal performance. Total sales in the June quarter jumped 24%, with organic sales, excluding acquisitions, up nearly 12%.

Conclusion

        Recent growth has been impressive, with per-share profits up 27% in the June quarter and 28% in the March quarter. Funded orders increased 24% to $2.29 billion in the June quarter, while the funded backlog grew 28% to $6.10 billion. Operating cash flow jumped 66% during the quarter, with free cash flow up 62%. Including the Titan acquisition, L-3 expects per-share earnings of $4.07 to $4.12 in 2005. Consensus estimates project per-share profit growth of 23% in 2005 and 18% in 2006. Trading at 17 times expected per-share earnings of $4.55 over the next 12 months, the stock trades at a slight premium to its five-year average forward P/E. An annual report for L-3 Communications Holdings Inc. is available at 600 Third Ave., New York, NY 10016; (212) 697-1111."
        Editor's Note: Richard Moroney is editor of Dow Theory Forecasts, 7412 Calumet Ave., Hammond, IN 46324, 1 year, 52 issues, $279. www.dowtheory.com.