Company Overview: L3Harris Technologies, Inc. (NYSE: LHX) is an active worldwide aerospace and defense technology innovator, engaged in providing end-to-end solutions that meet customers’ mission-critical requirements. The company is involved in offering advanced defense and commercial technologies across the sea, air, land, and cyber space. The company’s products, systems and services have the defense, civil government and commercial applications. The company has approximately 50,000 employees, comprising roughly 20,000 engineers and scientists, with customers in 130 countries.

LHX Details

Synergies from Integration & Cost Cutting Initiative are Key Catalysts: L3Harris Technologies, Inc. (NYSE: LHX) was incorporated post the merger agreement between L3 Technologies and Harris Corporation on Jun 29, 2019. LHX is a technology-focused company that offers innovative defense and commercial technologies across land, air, sea, space, and cyber fields. The company has four key business segments, namely Integrated Mission Systems, Communication Systems, Space and Airborne Systems and Aviation Systems.

In 2019, the company reported total revenues of $18.1 million, up from $16.4 million reported in FY18.  The company’s continuous strategy and focus aided it to deliver excellent results during the period. Further, revenues from Integrated Mission Systems contributed 21.8% of its total 2019 revenues, whereas Space and Airborne Systems contributed ~33.7% of the company’s total revenues. Coming to Communication Systems, this segment contributed 26% of the total 2019 revenues. The remaining 18.4% of total revenues came from Aviation Systems.

Coming to 2QFY20, the quarter marked the achievement of one year of the merged company formed through the combination of L3 Technologies and Harris Corp. As an amalgamation of these two industry loyalists has been consistent with the company’s plan, it expects to boost its operational performance through the deal in the days ahead. Additionally, revenues recognized from earlier defense contracts are also likely to aid the company’s top line, going forward.

It is worth noting that the company is on track to make notable progress amid the COVID-19 pandemic, which in turn has been reducing its overall cost structure. Especially, enhancements in overhead costs are expected to boost margins and enhance its bottom-line growth.  

The company remains on track to optimize its R&D investments by curbing the number of projects and redirecting its total expenditure from overlapping or discontinued programs to those with the best returns. Since the merger, the company has focused on improving its overall working capital, which aided it to generate ~$1.4 billion in adjusted free cash flow, while returning $1.8 billion to shareholders. The company also focuses to realign its portfolio to aim for high-margin, high-growth, technology-differentiated businesses to generate attractive returns. This is an ongoing effort and the company expects the momentum to be continued in 2020.

2QFY20 Key Financial Highlights: During the quarter, the company reported non-GAAP earnings of $2.83 per share, up 13% from the prior corresponding period. The company reported revenues of $4,445 million, which skyrocketed 138% on a year-over-year basis, driven by post-merger addition of L3 operations. Revenues increased 2.3% on an organic basis, on the back of growth in Integrated Mission Systems, Space and Airborne Systems, and Communication Systems, partially offset by a decline in Aviation Systems due to the pandemic. During the quarter, net income stood at $278 million, up 4% year over year. Adjusted EBIT during the quarter increased 9% year over year and came in at $810 million. EBIT margin increased 150 basis points and came in at 18.2%.

Key Highlights (Source: Company Reports)

Segment-wise Performance Highlights: During the quarter, the company reported robust performance from its Integrated Mission Systems, Space and Airborne Systems, and Communication Systems, which partially offset by a decline in Aviation Systems due to the coronavirus induced pandemic.

Integrated Mission Systems: The segment reported net sales of $1,331 million. On a pro forma basis, revenues increased 7.3%, due to an increase in Electro-Optical and Maritime units. Operating income (on a pro-forma basis) increased from $162 million reported in 2QFY19 to $224 million. Moreover, the operating margin stood at 16.8%, up 370 basis points from the year-ago period.

Space and Airborne Systems: Net sales from this segment came in at $1,249 million, which increased 23% year over year. Revenues on pro forma basis were up 4.1% on pcp due to F-35 platform growth in Avionics and classified growth in Intel and Cyber. Operating income stood at $235 million, as compared to $228 million reported in the year-ago quarter.

Communication Systems: Net sales and pro forma revenue during the quarter from this segment increased by 83% and 2.4%, respectively, on a year over year basis. The rise was on the back of ramp-up in U.S. DoD modernization programs in Tactical Communications and Integrated Vision Systems. Operating income increased from $239 million to $265 million, whereas operating margin expanded 180 bps year over year.

Aviation Systems: Net sales at the segment went down 17% and stood at $800 million, down 17% due to coronavirus induced pandemic in the commercial aviation business. Operating income also decreased from $109 million reported in 2QFY19 to $31 million.

Segmental Highlights (Source: Company Reports)

Balance Sheet Position: The company exited the period with a cash balance of $1,947 million, and long-term debt amounted to $6,273 million. At the end of 2QFY20, net cash inflow from operating activities stood at $1,335 million, up from cash inflow of $716 million reported in the year-ago period. The company remains on track to maximize cash flow with shareholder-friendly capital deployment. Adjusted free cash flow during the quarter stood at $785 million.

Cash Flow Highlights (Source: Company Reports)

Key Updates:

(a) On August 3, 2020, the company informed the market that it is back on track to commence building the U.S. Air Force’s first Navigation Technology Satellite-3 (NTS-3) post the completion of the program’s critical design review. The company will combine its program’s experimental payload with an ESPAStar Platform and expects to launch the same in 2022.

(b) In another update, the company received its 16th consecutive year of 2020 James S. Cogswell Excellent Industrial Security Achievement award from the U.S. Department of Defense for maintaining high standards in security procedures.

(c) On July 31, 2020, the company stated that it has completed the earlier announced divestment of its EOTech business to American Holoptics, an associate of Koucar Management.

(d) In June this year, the company divulged its man-portable Iver4 580 unmanned undersea vehicle (UUV), in order to address a wide range of customer missions, which includes survey, surveillance and reconnaissance, multi-domain intelligence, anti-submarine warfare, mine warfare and seabed warfare. The company expects encouraging synergies from this invention to contribute to its top-line growth in the coming quarters.

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together forms around 38.02% of the total shareholding. Vanguard Group, Inc., and BlackRock Institutional Trust Company, N.A. hold the maximum interests in the company at 8.93% and 5.79%, respectively.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Key Metrics: The Company reported Apr’20 gross margin at 28.7%, higher than the industry median of 25.3%. EBITDA margin during Apr’20, stood at 17.3%, higher than the industry median of 12.1%. Net margin in the same time span stood at 4.2%, higher than the industry median of 3.9%. Apr’20 debt to equity ratio stood at 0.33x, lower than the industry median of 0.49x.

Key Metrics (Source: Refinitiv, Thomson Reuters)

Key Risks: The company faces stiff competition from peers in the defense and aerospace, which include BAE Systems, Boeing, General Dynamics, Lockheed Martin, Northrop Grumman, Raytheon, Thales, and United Technologies. A significant portion of the company’s revenue comes from U.S. Government customers. This implies that customer concentration risk is higher for the company and the loss of these relationships, could have an adverse impact on its business. Further, adverse currency translations, high debt, volatile macroeconomic environment, and global pandemic led by COVID-19 outbreak are persistent challenges to the company.

Outlook: For FY20, the company expects organic revenues to grow in the ambit of 3-5%. Total revenues for FY20 is projected in the range of $18.2-$18.6 billion. For FY20, non-GAAP earnings per share is expected to be in the range of $11.15-$11.55. The company further projects operating cash flow and adjusted free cash flow to be in the ambit of $2.8-$2.9 billion and $2.6-$2.7 billion, respectively.

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology- EV/EBITDA Multiple Based Relative Valuation (Illustrative)

EV/EBITDA Multiple Based Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation: The stock of LHX closed at $172.14 with a market capitalization of ~$37.16 billion. The stock made a 52-week low and high of $142.01 and $230.99, respectively, and is currently trading below the average of its 52-week trading range. The stock gave negative returns of ~18.16% and ~2.74% in the last one year and one month, respectively. The company’s forward strategy is mainly focused on the merger benefits and continuous implementation of its strategic priorities, such as higher investments, expanding internationally and enhancing shareholders’ value. Considering the above factors, we have valued the stock using EV/EBITDA multiple based illustrative relative valuation method and arrived at a target price with an upside of lower double-digit (in % terms). For the purpose, we have taken peers like Boeing Co (NYSE: BA), Northrop Grumman Corp (NYSE: NOC), and Lockheed Martin Corp (NYSE: LMT). Hence, we recommend a “Buy” rating on the stock at the closing price of $172.14, up 2.9% on 5 August 2020.

LHX Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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