New York City-based defense contractor L-3 Communications reported its third-quarter 2015 earnings on Thursday. More precisely, it reported its third-quarter losses -- and they were indeed huge.
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Headlining its earnings announcement with a report of $2.8 billion in quarterly sales (analysts had been looking for $2.9 billion) and "adjusted diluted earnings per share" of $2.09, L-3 came very close to burying the lede.
True, analysts had been looking for L-3 to produce pro forma earnings of just $1.81 per share, and in that respect, the $2.09 L-3 says it "earned" came as a pleasant surprise (and probably explained the stock's 2% rise day-of). But even so, the really big news of the quarter was a massive $5.79-per-diluted-share charge to earnings taken on the company's National Security Solutions (NSS) business. Subtracted from the "adjusted diluted" result that L-3 had emphasized, that left L-3 smarting from a $3.74-per-share GAAP loss for the quarter.
Aside from that, Mrs. Lincoln...Be that as it may, L-3 worked hard to put a happy face on the quarter, with CEO Michael Strianese emphasizing the company's "higher segment operating margins" for the quarter, and its continued shift toward "structurally stronger, higher-yielding businesses where we maintain leading positions."
In this regard, L-3's strongest business by far was its Electronics Systems division (its second-biggest by revenue), where operating margins grew 120 basis points in Q3 to 12.5%. Second up was the company's smaller Communications Systems division (10.5% operating profit margin, 60 basis points better than last year).
The company's biggest business, Aerospace Systems, posted a 9.7% profit margin, 350 basis points better than last year. And its smallest division, NSS, posted only a 2.7% profit margin, down more than half from one year ago.
Of these four divisions, the last two -- L-3's biggest and its smallest -- both shrank in size year over year. The two others, Aerospace and Communications, both grew modestly, in the 2%-3% range.
ValuationGiven the various segments' various trends through the first three quarters of this year, L-3 has issued revised guidance featuring:
- Weaker projected sales of between $11.4 billion and $11.5 billion for the full year
- Weaker profit margins of 8.3% on these weaker revenues
- A massively lower earnings estimate, with per-share profits now expected to range from $0.93 to $1.03 for the year.
But ending on a happy note, management still thinks it can end the year with free cash flow of about $850 million, GAAP troubles notwithstanding. So where does this leave investors?
Weighed against the company's $10.3 billion market capitalization, these numbers imply a valuation of about 12.1 times free cash flow on the stock (16.4 times FCF when valued on enterprise value). Given that analysts quoted on S&P Capital IQ only expect to see L-3 grow its profits at about 7% annually over the next five years, however, these valuations seem optimistic -- and this is even after giving L-3 the benefit of valuing it on free cash flow, which currently looks a lot healthier than L-3's trailing GAAP earnings.
Accordingly, even though L-3's price-to-sales ratio is currently just 0.9, and even though that seems a historically cheap ratio for a large defense contractor like L-3, I cannot endorse the stock at today's valuation. In my opinion, L-3 simply costs too much to be worth buying at today's prices.
The article L-3 Communications Boasts of a Profit, but Posts a Massive Loss originally appeared on Fool.com.
Rich 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. 280 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.
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