Harris Communicates a Buy Signal
By Steve Alexander of MagicDiligence
NEW YORK (
) --
Harris
(HRS)
, a large communications product and services company, has decent growth potential.
Harris caters primarily to government customers, which account for 80% of revenue, with the U.S. federal government alone representing more than 65% of sales.
The Joint Tactical Radio System 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Old and outdated communications systems dog many municipal police, fire, and rescue organizations.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 newsfeed 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 also is a very active acquirer. Just last month it purchased
Schlumberger's
(SLB) - Get Report
satellite business, which combined with the July purchase of
CapRock
, expands the company's push into the energy market. In the oilfield 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.
Harris' 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.
Harris' broadcast division, which is unprofitable, is by far the least attractive business and a potential candidate for divestiture or spinoff. It would not be unprecedented -- Harris spun off Harris Stratex Networks (now Aviant Networks), 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 five-year average earnings yield is a shade over 10%, and the three-year figure is 12.8%. Still, with a current earnings yield of 14.5%, the stock looks cheap at $45 and change. Assuming modest growth 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.
Alexander has no position in any stocks discussed in this article
.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.