Will FLIR Fly?

By Keith Speights - June 7, 2012 | Tickers: FLIR, GRMN, LLL, ROP | 0 Comments

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FLIR Systems (NASDAQ: FLIR) stock skyrocketed over the past ten years. Shares of the infrared technology company soared from less than $5 in 2002 to a high of over $40 in 2008. The stock has come down significantly from those lofty heights, though, and now trades for less than $22 per share. Is FLIR’s successful run a thing of the past or can the stock fly high again?

My predictions are that:

1. FLIR will regain momentum
2. It might take a while
3. FLIR‘s growth will be slower than in the past

Here’s my rationale.

FLIR will regain momentum
The main reason that FLIR is likely to succeed over the long run is that the world is still a dangerous place. I would put special emphasis on the word “world.” FLIR currently receives 47% of revenues from international customers and 53% from U.S. customers. Look for that ratio to skew more heavily to the international side over the next few years.

In particular, emerging markets including the BRIC countries offer significant potential for growth. Their law enforcement agencies are likely to purchase security and traffic control products. The militaries in friendly governments throughout the world are probable customers for FLIR’s technology, including CBRNE (chemical, biological, radioactive, nuclear and explosive) detection solutions.

The company has also done a good job in diversifying its product line to go beyond selling primarily to governmental entities. The company obtains 52% of revenues from its Commercial Systems division. Solid growth prospects exist in commercial security, automotive, marine and industrial usage for thermal imaging technology. This is especially true for emerging markets. As these countries grow their economies, native companies will have increased need for sensor technology that FLIR provides.

FLIR competes in various markets, including defense, marine navigation, and sensors. The companies battling for market share tend to be bigger than FLIR, but FLIR holds its own. The table below shows how some key competitors compare with FLIR:

L-3 Communications (NYSE: LLL) and FLIR have attractive forward P/E values, but FLIR’s PEG reflects more room for price appreciation. Garmin (NASDAQ: GRMN) and Roper Industries (NYSE: ROP) have higher P/E and PEG values. Neither appears to be a better buy than FLIR at this point.

FLIR’s P/E has typically traded in the 16 to 23 range over the past three years. Share prices would need to increase by over 30% to reach the lower end of the historical range.

The bottom line is that FLIR is priced at a historically low level. Its products will continue to be needed by governments and by companies. FLIR compares favorably with its competitors across product lines. The company’s increased investments in R&D should help it maintain its strong competitive position. Regaining momentum appears likely.

It might take a while
However, I’m not convinced that FLIR will take off in the near term. There are substantial headwinds in the current economic environment.

First, FLIR still depends on the U.S. government for 29% of revenues. The high levels of government spending and its accompanying debt will be a prime topic for this election cycle. With potential defense cuts looming (perhaps even if the sequestration deal made by Congress last year is circumvented), FLIR could be impacted negatively. The U.S. military isn’t likely to suffer draconian cuts. However, the question hanging in the air over potential budget decreases won’t be answered until near the end of the year.

Second, the world economic prognosis is uncertain. It could take a long time for an ultimate resolution to the European financial situation. China’s economy appears to be slowing. The U.S. picture is tentative also. These conditions could result in companies decreasing their purchasing levels for FLIR technology.

I don’t anticipate that these factors will dampen FLIR’s prospects over the long-term, but they probably will make it less likely for a strong rebound in the stock’s price over the next few months. The current European crisis will ultimately be resolved one way or the other. Europe will emerge from its current mild recession. China’s slowdown might not fully materialize. Even if its economy does cool off for a while, China will roar back. 

What we don’t know is how long it will take for all of these situations to be rectified. FLIR could move upward in the meantime, but I’m not counting on it. 2013 looks to be a more promising year.

FLIR’s growth will be slower than in the past
It really doesn’t take infrared vision to see that FLIR is not likely to grow at the pace that it has historically. The flurry of stock growth in the 2000s came on the heels of the 9/11 attacks and two wars in Afghanistan and Iraq.

FLIR’s numbers reflect the reality of its slowing growth. Earnings per share for 2011 were $1.38, down from $1.54 the previous year. Cash flow is down also, as the chart below shows.

Things are not bleak by any means. The company is in good financial shape. Revenues are growing. Cash flow is strong. Debt is manageable. However, the staggering growth of the past is in the past.

When - Not If
Any stock can suffer in an overall down market. FLIR is no exception. Current uncertainties might even pose a bigger problem for FLIR than other companies. However, I think it’s a question of when FLIR shares will rise rather than if they will rise.

The company is a leader in the thermal imaging market. Demand for its technology might be muted for a while, but the long term prospects are good. The stock is attractively priced and should see considerable gains by merely returning to the lower end of its historical P/E range. Sooner or later, I think FLIR will fly again.

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