FLIR Systems Could Reach $35 By 2013

Helen is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In 2011 FLIR Systems (NASDAQ: FLIR) restructured and now operates in two divisions, commercial systems and government systems.  The government division was down 5% to 46% of corporate sales in 2011 versus 2010.  Unfortunately for FLIR, the government sales are falling faster than the commercial systems segment can increase sales.  At this point FLIR needs to focus more on commercial systems because government spending isn’t going to increase anytime soon.

FLIR is competing against companies such as L-3 Communications (NYSE: LLL), Raytheon (NYSE: RTN), and Lockheed Martin (NYSE: LMT).  FLIR is the baby with a market cap of just over $4 billion while its competitors have market caps of $6.7 billion, $17.6 billion and $28.5 billion respectively.

In a release of earnings for 2011 FLIR’s CEO talked about operational efficiency and innovation.  The report also talks about 2012 net income growth guidance of 16%-23%.  Since I don’t see much sales growth happening, the majority if not all of this would have to come from increased efficiencies and innovations.  I am encouraged by FLIR’s balance sheet however.  It carries only $250 million in debt, and that was just recently issued.  It has over $400 million in cash on hand.

I don’t think FLIR will see huge losses from government spending cuts, because military leaders plan to combat the troop reductions with an increase in Special Forces (SF) and unmanned drones.  I think the increases in some products will offset losses in others and keep the government division flat for 2012.  FLIR builds man portable systems for SF and vision, targeting, and observation systems that can be mounted to drones or other vehicle platforms.  In addition to overseas, similar systems are being used to offset the manpower cuts along the U.S. borders and at sea in the war on drugs.  The Army National Guard and other reserve component forces are starting to be fielded with drones, which means increased use for homeland defense and disaster response.  This should help show the value of drones and bring about increased spending by non-military agencies to acquire these valuable tools that carry FLIR systems.

On the commercial side FLIR is marketing systems for use on personal cars, trucks, etc., to make night driving safer for people that frequently drive after dark.  On the radio I recently heard about proposed legislation in congress requiring automakers to install backup cameras on all vehicles by 2014.  If FLIR can get this drive at night technology to be successful, beneficial, and cost effective, it could lobby for legislation requiring its system on all cars.  And I think that would be more beneficial to driver safety than backup cameras.  This could help give FLIR a growth spike and then long term sustained income if it could secure contracts with the big auto makers to provide those systems.

FLIR’s industrial products in the commercial systems division compete against Dahaner Corporation’s (NYSE: DHR) Fluke segment.  Fluke’s sales for 2011 were approximately $3.3 billion.  While that number is twice the number of FLIR’s total sales, operating margins between the two companies are equal around 22%.  According to Dahaner’s 2011 10-K, it bought Fluke in 1998 to establish is test and measurement segment.  It has also been buying up other companies to help grow the segment.  Of the test and measurement’s 19.5% sales growth, 8% of that came from acquisitions.  Dahaner’s balance sheet is a little unsettling however with only $500 million in cash to over $5 billion in debt.  Upon further investigation this is what is left after issuing some stock and taking additional loans for other acquisitions in other areas.  Going forward however, if half of its growth is coming from acquisitions, it needs to focus on organic growth or Fluke’s parent company will have some issues that could impact Fluke.  In the meantime, FLIR is able to grow itself without relying on acquisitions.

FLIR’s government division has many more competitors: L-3, Raytheon, and Lockheed Martin to name a few.  As mentioned above, FLIR is the smallest of these companies, but its sole focus is infrared technologies while the other companies are much more diversified.  A look at price-to-earnings ratios tells us that FLIR is the most expensive of the four companies: 19.1, 7.8, 10.1, and 11.6 respectively.  In this category FLIR is dependent on providing systems that can be man portable or strategic alliances that use FLIR’s vehicle mounted systems.  For instance, it just received several contracts to provide the U.S. Army and Navy with several systems.  Each contract is reported to be valued “up to” a certain dollar amount.  Well that means the Army could never execute $1 of the contract or execute the full amount.  Unfortunately many of the contracts are tied to platforms (MEDEVAC helicopters for example) currently in use in Iraq and Afghanistan.  With the wars ending and forces withdrawing, the number of vehicles with these systems will be reduced and I expect most of those contracts will not reach their full potential.  The other companies in this group provide full platform solutions from unmanned drones to manned combat vehicles.

This is unfortunate for FLIR because with each of these companies having its own infrared production or long standing strategic alliances with larger companies, they don’t need to purchase the systems from FLIR.  And it doesn’t make sense for the Navy to order a Lockheed drone with FLIR infrared because it can get similar technology and a better price from all one source.  FLIR needs to work on securing more strategic partners if it wants to have staying power.  Several of Lockheed’s products utilize infrared technologies from Raytheon, Northrop Grumman, and BAE Systems.  Lockheed however, could be a potential suitor if it wanted to buy FLIR and have its own infrared capability.  Lockheed has plenty of access to cash so a cash acquisition of this amount should be no problem. 

I think FLIR is a fair buy at this level.  Since it is confident in its ability to increase efficiencies and see net income growth even with slowing sales.  If nothing else it is a good dividend and one to hold on to until the next major conflict starts and government orders pick up.  I think shares could see $30-$35 by the end of 2012 as long as it can keep the efficiency plan on track; and would buy after a small pull back. 

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