We maintain a Neutral recommendation on
L-3 Communications Holdings Inc.
) reflecting our concerns regarding the loss of key contracts, a
backlog skewed toward fixed price contracts and possibilities of
cuts in future defense budgets. The company holds a Zacks #3
Rank, which translates into a short-term Hold rating, and
correlates with our long-term recommendation.
L-3 Communications Holdings operates through its wholly owned
subsidiary, L-3 Communications Corporation. L-3 Communications is
a leading supplier of a broad range of products and services used
on a number of aerospace and defense platforms. In addition, the
company is a prime system contractor for aircraft modernization
and maintenance; simulation and training; and government systems
Earlier, in July 2012, L-3 Communications completed the spin-off
of a new, independent, publicly traded government services
Engility Holdings Inc.
) - to L-3 shareholders. We believe that L-3 Communications has
ample opportunity for growth and profit expansion after the
favorable conclusion of the spin-off of its Government Services
The company has retained its profitable Cyber, Intelligence
and Security Solutions business. The spin-off also removes a lot
of uncertainty with respect to revenue and takes away some of the
low margin businesses of the company.
Over the longer run, we view the company as one of the
best-positioned pure defense players based on its non-platform
focus, prominent position as sub-contractor/supplier to other
defense primes, broad diversification of programs and strong
order bookings. Its strong balance sheet also provides financial
flexibility to increase its dividend, indulge in share
repurchases and earnings accretive acquisitions.
We believe future growth will come from its strong presence in
the areas it currently focuses on. These include command,
control, communications, intelligence, surveillance and
reconnaissance (C3ISR) equipment; precision-guided weapons;
unmanned aerial vehicles (UAVs); and other electro-mechanical
robotic capabilities, networked information technologies, special
operations forces, platform upgrades and counterterrorism
On the flip side, however, a substantial portion of L-3
Communications' business is generated within the U.S, with
government and commercial sales accounting for 82% of sales in
fiscal 2011. Budget deficits and political uncertainty looms on
future defense budgets with high chances of shrinkage.
Moreover, more than half of L-3 Communications' sales in
fiscal 2011 came from fixed priced contracts. Consequently, the
company will only be able to make a profit if costs stay within
the set limits. Given these headwinds, we maintain our Neutral
stance on L-3 Communications.
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L-3 Communications mainly competes with
Honeywell International Inc.