Unless Congress can agree on a plan to stave off cuts scheduled to begin in January, military spending will be reduced by $492 billion over a decade, with the first $55 billion cut in January. Domestic programs also will face reductions by $492 billion over a decade. These automatic cuts will occur because of the bipartisan congressional panel's failure last year to agree how to cut the deficit by $1.2 trillion over 10 years.
While not much will happen before November's elections, defense companies have already begun preparing for these cuts.
GD's chart should sound some alarms. Revenue is declining while accounts receivables and days sales outstanding are increasing. Receivables as a percentage of revenue are at 127% and growing. GD's high cost of sales means its gross margin is only 18%, which does not leave much room for operating or profit margins. In the face of potential defense spending cuts, GD added 5,000 employees last year and 11,500 since 2007. The company's cash conversion cycle -- the time it takes to convert sales to cash -- also has grown from 95 days to 115 days in two years. The government takes its sweet time paying its bills.
More alarms: Unearned revenue on the balance sheet -- prepayments for work or products that have not been delivered -- is declining and is a paltry $1.049 billion. GD also has $269 million and $310 million in deferred tax assets, and long-term deferred tax assets, respectively. This is a reserve account that will be used to pay future tax liabilities, and it will hurt cash flow when the account has been depleted. Last but not least, GD has a negative $4.68 tangible book value per share.
On Friday, June 8, the Navy awarded Raytheon
While most of Raytheon's metrics are better than GD's, alarm bells clang around its negative tangible book value of -$12.64 a share and rising long-term debt, which stands at $4.606 billion. Raytheon is not going out of business anytime soon, but tangible book value equals assets minus liabilities and intangibles like goodwil. The stock price has hardly moved since January, and the forward P/E of 9.16 is only slightly better than the trailing P/E of 9.41. This means that estimated earnings are not great. Perhaps the only thing great about owning Raytheon is the current 3.90% annual dividend yield ($2.00).
Alarm bells! Staffing dropped from 117,110 to 72,500 last year but 38,000 of the 44,610 jobs lost went with Huntington Ingalls Industries
Northrop's trailing P/E of 7.76 is smaller than the forward P/E of $8.54. Northrop pays a $2.20 dividend (3.60%), but there are a lot of safer stocks out there.
Hard economic times warrant taking a defensive posture with your portfolio. Defense stocks are not defensive investments! Foolish readers should always make their investment decisions based on earnings quality.
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