L3Harris: A Great Stock We Think Is Poised To Move Up (NYSE:LHX)

DISCLAIMER: This article is not directed at, nor intended to be relied upon by any UK recipients. Any information or analysis in this article is not an offer to sell or buy any securities. Nothing in it is intended to be investment advice and it should not be relied upon to make investment decisions. Cestrian Capital Research Inc or its employees or the author of this article or related persons may have a position in any investments mentioned in this article. Any opinions or probabilities expressed in this report are those of the author as of the article date of publication and are subject to change without notice.

Background

We cover most all the defense and space majors here at Cestrian Capital Research, and in the last year we have owned most of them too. It’s been a great group of stocks to own. We sold out early as the crisis hit (as we detailed in our recent blog post here) and sat waiting for opportunities to deploy cash. We prepared a shopping list of our top picks, and waited some more.

We see the 2020 Presidential election as a catalyst for stocks. There may be some more red ink to endure yet, but we believe the market will be moving up come Q3. You can read our latest market update blog post here. (We figure that if we lay out our own opinion and prejudice about market direction, you can read our stock-by-stock coverage with our own lens in mind).

Our top pick in the sector was Lockheed Martin (LMT), which we’ve written about before in these pages. Our second was L3Harris (LHX). Last week we bought into both stocks. We’re particularly excited about LHX right now.

A Huge Winner Over The Last Three Years

First, some history. Here’s the last three years of LHX versus the S&P500 in the form of its proxy ETF, SPY – this on a total return basis.

Source: YCharts.com

Pretty awesome performance – it’s stayed ahead of the S&P the whole time. Amazingly, if you had bought the stock three years ago and held through the current crisis, your percentage gain at its lowest point during the crisis was similar to the percentage gain you would have enjoyed at the very peak of the market if you had bought SPY with your money instead. Think about that for a moment. You can also see the very sharp rebound once the market turned up this last week.

We think the stock can continue to outperform. Here’s why.

Market Backdrop

As we say in most of our work right now, leave your politics at the door. Forget whether you like or don’t like the current Administration. Focus on what the current Administration’s proximity to an election means for stocks.

We think that the federal government has made an internal declaration, not written down anywhere, that SPY at 220 – the rough level the market was at when the current Administration took power – is the bottom. We believe that the government will be doing absolutely everything in its power, everything, to have the market moving up into the Presidential election. Be it by monetary or fiscal stimulus, we think the DC bazooka is going to shower cash on the corporate landscape every time there is a slew of bad news from the real world.

We might see SPY at 220 tested again, maybe soon as the truly terrible numbers and stories about Covid-19 continue. But we don’t believe we’re going below 220. We believe the market will climb towards the end of the year. To at least, say, 275. That way, when campaigning, the current Administration can say, hey, we were hit with a curveball taking the market down, and we still managed to pull it up by 20% or so in just a few months. Trust us with your 401k. Vote for us again. Four more years.

So in short we believe that we are buying into market which will be moving up come Q3 and Q4. Not a smooth-sailing, up-every-day market, we can see plenty of rocky road ahead – but up nonetheless.

Not All Stocks Will Recover Equally

If you ask any company right now, “what does 2020 look like”, they will all tell you the same thing. “No idea”, or, “it will be OK assuming we get this virus problem resolved”.

But whilst we think the market will in the end lift all boats to a degree, regardless of nobody offering solid guidance, we think that LHX is particularly well placed to race out of the gate.

Firstly, its revenues are predominantly from the federal government, and we don’t see any underlying slowdown in defense spending anytime soon. Demand for LHX products remains intact and even if fulfilling that demand is challenging – you can’t make battlefield electronics in your pajamas over Zoom (ZM) – the principal customer will wait. Where else are they going to go? And, what, the world is going to get less tense next year?

Secondly, the stock is a well-known high performer and once we see the market rising up sustainably from this big correction, investors will look to LHX as a source of protection, not just growth.

And finally, the fundamental valuation on a trailing basis is more than reasonable right now.

LHX Fundamentals

Following the merger between L3 and Harris Corp, the financials of the combined business can only really be understood on a “pro forma” basis ie. by treating the business as if it had always existed in this form. That way we can try to compare like with like.

Here’s how LHX management present the combination in their SEC filings – this was prior to the crisis – you can safely ignore their guidance for 2020, we would suggest.

Source: LHX SEC filings.

You have a company with $18bn in revenue growing at 10% last year and, prior to the current virus situation, forecasting 6% growth this year. (LHX’s financial year ends December).

Now turning to valuation for a moment.

Even after a pandemic has rendered the world immobile and unable to go to work or the store, this company is still valued at over 2.4x current year guide revenue when everyone assumes they won’t hit the guide.

Source: YCharts.com

That’s impressive. It tells you the market has confidence in the stock even when the real economy is under severe pressure. You can see that in LHX’s performance year to date too.

LHX Stock Is Proving Resilient In This Downturn

We bought the stock last week, together with a handful of other top-grade names (among them Veeva Systems (VEEV)), on the basis that one rarely gets the opportunity to buy very high quality companies at a discount, and whilst the stock could still move down, we were happy to take that risk in exchange for the long-run upside of buying in an environment where the S&P500 was down 20% YTD.

Let’s look more closely at how the stock has behaved this year to date. Down 8% on a total return basis, vs. down 20% for the S&P500. This is why we don’t mind buying in at this point – if there is another re-test of market lows, we anticipate being better protected in this name than most, and given we assume we aren’t smart enough to call the bottom perfectly, we’re happy to ride the stock down a little if necessary, in anticipation of a long, multi-year ride up.

We’ll be covering LHX in detail going forward and will share some of our coverage with you here on SA.

Cestrian Capital Research, Inc – 31 March 2020.

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Disclosure: I am/we are long LHX, VEEV, ZM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: We are long LHX, VEEV and ZM, and short SPY, on a personal account basis.

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