Harris Corp is Communicating a Buy Signal
Harris has three business segments. The largest is Government Communications Systems (GCS), which is just over 50% of sales. This business is quite diverse, ranging from designing and running the Federal Aviation Administration's (FAA) air traffic control systems to instrumentation and avionics for the F-35 jet program to managing information technology for the Veteran's Association's (VA) health care management systems. In all, this segment has over 300 programs.
The second largest segment, and probably the best-known, is RF Communications (about 40% of sales). Primary products here are secure wireless voice and data communications items for domestic and foreign militaries, as well as federal/state/local law enforcement and public safety groups. Examples include hand-held and vehicular radios, mobile communications network equipment, and even embeddable semiconductors.
The smallest segment is Broadcast Communications (9%), which is currently unprofitable. This business provides workflow systems for production of video and audio programming, as well as transmission and network management equipment. Some recent visible examples of services here include support for McDonald's (MCD) in-store television network, as well as the arena broadcasting system for the Orlando Magic.
Harris has decent growth potential. The Joint Tactical Radio System (JTRS) is the U.S. military's "next-generation", software-based radio framework, and Harris' Falcon III line is the first to be certified JTRS compliant. Only about 10% of the military's radios meet this requirement, so Harris stands to benefit from future orders.
Old and outdated communications systems dog many municipal police, fire, and rescue organizations. Over time, money will have to be appropriated to upgrade them, and Harris is a market leader. Browse the company's news feed and you'll see no shortage of small-to-medium size contract wins for modernizing a city or state's communications systems. This should be a long-tail trend to benefit the firm. Similar but much larger scale opportunities exist at the federal level for various military and civilian organizations. The breadth of Harris' communications applications extends from voice to video and an amazing diversity of data applications (weather, geologic, command-and-control, intelligence, you name it).
Harris is also a very active acquirer. Just last month they purchased Schlumberger's (SLB) satellite business, which combined with the July purchase of CapRock, expands the company's push into the energy market. In the oil field services business, satellite data is highly valuable in determining potential drilling locations and the need for mobile communications to and from rigs is acute. I expect more deals to be a key factor in driving revenue growth.
Competitive position is strong. The firm's radios are the de-facto military standard for NATO, which ensures the company of both replacement demand and a leg-up on developing and supplying next-generation devices for most countries. Many of the GCS contracts run for many years, and consist of extremely "sticky" systems that would be very difficult for the government to swap out to a competitor. The Broadcast division is by far the least attractive business and a potential candidate for divestiture or spin-off. It would not be unprecedented - Harris spun off Harris Stratex Networks (now Aviant Networks (AVNW)), the IP radio backhaul unit, in 2009.
At first glance the balance sheet looks concerning, with just $340 million in cash against $1.5 billion in debt. However, no significant debt is due until 2015, and near-term health looks fine with a current ratio of 1.4 and an interest coverage ratio over 14. Harris generates strong, reliable, and growing free cash flows. Free cash flow margin has increased from about 7% in 2006 to over 15% currently. With a nearly $800 million free cash flow run rate, I believe the firm's financial health is fine.
Like most defense contractors, Harris has never been a particularly richly valued stock. The 5-year average earnings yield is a shade over 10%, and the 3-year figure is 12.8%. Still, with a current EY of 14.5%, the stock looks cheap at $45 and change. Assuming modest growth going forward and an average earnings yield of about 12%, Harris looks to be reasonably worth about $62. If you include the decent 2.2% dividend, that represents a 38% appreciation from current levels.
That is good upside, combined with growth potential, a strong competitive position, solid financial health, and even relatively strong business momentum with a Piotroski score of 7. MagicDiligence has a positive, "buy" opinion on the shares.
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