FLIR Systems, Inc. Lights a Fire Under It

By Markets Fool.com

The middle of a defense spending slowdown, compounded by a "sequester,"isn't supposed to be a good time to own defense stocks. Luckily for investors, someone forgot to tell that to FLIR Systems last week.

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On Friday, FLIR reported fourth-quarter and full-year earnings for 2014. Full-year results were good -- with profits up 14% despite sales growth of only 2%. But it was in Q4 in particular that FLIR Systems really lit a fire under its results: Sales were up 8% to $434 million -- four times as fast as the year's total. Profits were up 155%, to $0.51 per diluted share.

Commenting on the numbers, CEO Andy Teich pronounced himself "pleased" at how "reducing [FLIR's] operating costs" had helped to boost profitability. He promised further that through "continuous improvement" the company would continue to produce "sustained long term growth."

FLIR's short term isn't looking too shabby, either.

Commenting on backlog, Teich noted that although orders awaiting fulfillment declined slightly in Q4, overall, backlog numbers are up 12% from where they stood at year-end 2013. Accordingly, FLIR is looking forward to sales of anywhere from $1.55 billion to $1.6 billionin the coming year (as much as 4.5% growth year over year). And with FLIR's improved profit margins, that could yield profits of $1.60 to $1.70 per diluted share -- as much as a 22% improvement over 2014 levels.

Valuation
At FLIR's current share price of $34, that works out to a 20 P/E ratio on the stock, and 22% profits growth would be more than enough to qualify FLIR stock as "cheap." But there is one caveat -- and it's a big one.

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Flipping over to FLIR's cash flow statement, we see that despite the sizable growth in reported GAAP profits, FLIR's not generating quite as much cash as we might like to see. To the contrary, declining cash from operations, combined with rising capital expenditures, left FLIR with free cash flow of only $165 million in 2014. That's 18% less cash profit than FLIR reported for its year's net income. It's also more than a 45% decline from FLIR's 2013 free cash flow number. Indeed -- it's the least amount of cash profit FLIR has generated in a year, since 2011.

FLIR generated so little cash profit in 2014, in fact, that when we calculate a price-to-free cash flow ratio, we find the stock selling for a 29 multiple on this metric -- significantly higher than the 20 P/E. This, in addition to the stock's above-average-for-a-defense-stock price-to-sales ratio of 3.0 tells me the stock's not quite as attractive an investment as the P/E may make it seem.

The upshot for investors
When you get right down to it, I think that the 7% jump in share price that FLIR investors enjoyed Friday may be about all there is to be had. For the time being, at least, the stock looks like dead money -- at least until FLIR figures out how to generate more cash from its business. That's why, for my part, I'm cashing out my "virtual" recommendation of FLIR stock on Motley Fool CAPS (at a profit, by the way), effective immediately.

The article FLIR Systems, Inc. Lights a Fire Under It originally appeared on Fool.com.

Fool contributorRich Smithdoes not own shares of, nor is he short, any company named above. You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 287 out of more than 75,000 rated members.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.