Earnings Preview: L-3 Communications Holdings

L-3 Communications Holdings Inc. (LLL) is scheduled to report its first quarter 2011 earnings results before market opens on April 21. The Zacks Consensus Estimate for the first quarter is earnings of $1.82 per share, down from $1.87 earned in the year-earlier quarter.

For full year 2011, the Zacks Consensus Estimate stands at $8.42 per share, representing a 0.94% increase from the prior-year earnings of $8.35 per share. The full year 2012 earnings estimate is currently $8.88 per share.

In February this year, L-3 Communications’ board of directors approved an increase of 12.5% in the dividend rate on its common stock. On an annual basis, the dividend comes to $1.80 per share or 45 cents per share on a quarterly basis. The increased dividend for the quarter was first paid on March 15 to shareholders of record as of March 1.

Previous Quarter Performance

L-3 Communications’ fourth quarter EPS went up 23% to $2.37, comfortably surpassing the Zacks Consensus Estimate of $2.31. Revenues inched up 1% year over year to $4.3 billion, beating the Zacks Consensus Estimate of $4.2 billion.

The top-line growth was driven by its command, control, communications, intelligence, surveillance and reconnaissance (C3ISR) and Electronic Systems segments partly offset by lower sales from the Government Services and the Aircraft Modernization and Maintenance segments.

Earnings Estimate Revisions

Ahead of the earnings release, we see clear downward movement in estimate revisions of the L-3 Communications stock. Looking at the trends, it becomes clear that analysts are cautious on L-3 Communications’ prospects in the near term.

The apprehension reflects our concerns regarding the loss of key contracts, a backlog skewed toward fixed price contracts and possibilities of cuts in future defense budgets. Also first quarterly numbers is slated to be affected by a debt retirement charge of $18 million or 10 cents per share in connection with an early redemption of $650 million of Senior Subordinated Notes originally due in 2015.

Of the 16 analysts covering the L-3 Communications stock, 2 and 4 have reduced their estimates in the last 7 and 30 days respectively; for the first quarter of 2011, with no upward revisions. For full year 2011, 1 and 3 analysts have revised downward their estimates in the last 7 and 30 days and only 1 moved in the opposite direction in the last 7 days. For full year 2012, 2 moved south in the last 30 days with no contrasting revisions northward.

Magnitude of Estimate Revisions

Looking at the magnitude of estimate revisions, we find a steady downward trend. Over the last 7 and 30 days, the Zacks Consensus Estimate for the first quarter fell by a penny and 2 cents, respectively; to $1.82 per share.

For full years 2011 and 2012, estimates over the past 30 days have nudged down a cent and two cents respectively; each to $8.42 and $8.88, respectively. The marginal downward trend by the analysts suggests that, while retaining the share would be beneficial for investors, they should wait for a more favorable entry point.

Earnings Surprise

L-3 Communications’ performance has been consistently positive over the trailing four quarters with respect to earnings surprises, with all the four quarters showing a positive surprise. The average earnings surprise was a positive 4.1%, implying that the company has beaten the Zacks Consensus Estimate by the same magnitude over the last four quarters.

Conclusion

We believe that L-3 Communications by virtue of its non-platform focus, prominent position as sub-contractor/supplier to other defense primes, broad diversification of programs, strong order bookings and an order backlog at the end of 2010 stands out among other pure defense players.

Its strong balance sheet provides it the financial flexibility to increase its dividend, indulge in share repurchases and earnings accretive acquisitions. In 2010, the company acquired four companies, which extended its product line, raised its expertise in niche fields and expanded its reach to customers with specialized needs in the defense industry.

However recently, some of the product lines such as the commercial ship building and combat propulsion systems have put in a weak performance. The downward trend in margins for service-related work due to competitive pressure witnessed during service contract renewals and new contracts in the Government Services segment is a matter of utmost concern. Also, margins plunged for airborne intelligence-surveillance-reconnaissance logistics support and fleet management services to the U.S. Department of Defense (DoD).

A substantial portion of L-3 Communications’ business is generated within the U.S, with government and commercial sales accounting for 87% of sales in fiscal 2010. Budget deficits and political uncertainty make future defense budgets vulnerable to cutbacks.

Moreover, more than half of L-3 Communications’ sales in fiscal 2010 came from fixed priced contracts. Consequently, the company will only be able to make a profit if costs stay within the contracted limits. Given these headwinds, we maintain our ‘Neutral’ stance on L-3 Communications. L-3 Communications also holds a Zacks #3 Rank, which translates into a short-term Hold rating, and correlates with our long-term recommendation.

L-3 Communications operates through its wholly owned subsidiary, L-3 Communications Corporation. The company is a leading supplier of a broad range of products and services used in a number of aerospace and defense platforms. It competes with the likes of Honeywell International Inc. (HON), Lockheed Martin Corporation (LMT) and Raytheon Company (RTN).

HONEYWELL INTL (HON): Free Stock Analysis Report

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