Defense Contractors You May Have Missed

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A couple of lesser known suppliers to the U.S. defense industry have experienced sharp run ups in their stock prices. An overview will illustrate if the jumps were warranted and if there may be more positive momentum behind the shares. In fact, these upturns were in line with those of some of the major defense contractors such as Northrop Grumman and Lockheed Martin. There may be other value propositions as well.

FLIR Systems (NASDAQ: FLIR)

Given cuts in spending by the U.S. Department of Defense, FLIR was an unlikely candidate to fare well, given that nearly 40% of revenues stem from its Government Systems unit. Indeed, sales from the Surveillance, Detection, and Integrated Systems businesses declined 6% in the March quarter, with profits falling by a steeper percentage.

However, FLIR has transformed into primarily a supplier of commercial-based products, mostly by way of acquisition. For one, several years ago, it bought out Raymarine, a provider of thermal vision and other electronic products for use in the marine market. Notably, too, in December, 2012, FLIR bought a maker of video surveillance systems, as well as Traficon International NV, a producer of video imaging processing hardware and software for traffic analysis applications. The buyouts are supporting revenues, but probably crimping the operating margin a bit, with an overall slightly positive effect on earnings.

Based on solidly higher backlogs in the Thermal Vision and Measurement, along with the Integrated Systems division, sales and earnings are poised to increase double-digit percentages this year.

GenCorp (NYSE: GY)

The approximately $1 billion market cap maker of propulsion systems for major defense contractors has a growing revenue stream. It is, though, up against a setback it has experienced in the past, specifically excess retirement benefit expenses. A low discount rate is limiting the returns on its retirement plan by increasing the required contribution.

As a result, GenCorp fell into the red in February. Costs related to the pending acquisition of Rocketdyne might also be restraining the bottom line. GenCorp completed the purchase of that business several weeks ago for about $550 million. It issued about $460 million in debt to fund the purchase of the former United Technologies unit. It is unclear what impact the new unit will have on results.

GenCorp stock should be considered only by aggressive investors, in light of its volatile earnings. Those that believe it will shore up the benefit expense issue and allow results to get back on track may want to take a chance.

CAE (NYSE: CAE)

Canadian CAE is involved in training and services for civil and military employees, as well as the production of simulation products for both end markets. The company's growth engine appears to be in civil training, where it is inking contracts with the likes of LAN, TAM, and numerous other overseas airlines, as well as GE Capital Aviation Services and Ryannair. Unfortunately, though, margins are under pressure. This might be partly due to the need to integrate its recent acquisition of Oxford Aviation Academy Luxembourg.

Elsewhere, the civil product market is trending positively. CAE may be up against some restraints from defense budget reductions in its military businesses. In all, it is probably positioned to perform better after the current quarter, when profitability of the civil training business is improved.

Thus, at its recent price quote, CAE shares offer an opportunity for upside. Analyst estimates and projections could prove conservative as the company continues to enter new deals and possibly further acquisitions. Otherwise, additional setbacks in the civil training unit may take a toll on results.

In closing

Now may not seem the ideal time to invest in military suppliers, as budget cuts are hampering results for many. Nevertheless, these niche players have positive momentum on their side. Investments in profitable business lines can be a boon to companies' bottom lines, as may be the catalysts for FLIR and CAE. All three here would benefit from cost containment activity, given their positive revenue trends and narrowing margins. Such improvements might help to lift their stocks further over the course of this year and beyond.


Damon Churchwell has no position in any stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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