Defense contractor L-3 Communications (NYSE: LLL ) enjoyed a banner year for its stock in 2013, gaining 39% in 12 months of trading. But heading into its Thursday earnings report, things were looking pretty bleak for the company. Earnings for the year were expected to be only $8.30 or thereabouts, less than a 4% increase over 2012 levels, and probably too little growth to support the stock's 13-times earnings P/E ratio. But then the numbers came out, and a miracle happened:
- 2013 sales declined 4% to just $12.6 billion, setting the stock up for a big drop in profits.
- Operating profit margins slipped 30 basis points (to 10%), potentially magnifying the drop.
- Yet somehow, L-3 managed to grow its earnings per share anyway -- up nearly 7% to $8.54.
Well, a couple of factors worked to L-3's benefit in 2013. For one thing, with profitability being a bit lower, taxes didn't bite as deep. L-3's effective income-tax rate declined by four full percentage points, to 28.2%. For another thing, this defense company did what it could to defend its shareholders, deploying cash in a series of buybacks that shrank its share count by nearly 7%.
Result: Even though overall net profits declined, the fact that these profits were spread out among fewer shares resulted in a modest increase, rather than a decrease, in profits per diluted share.
Second verse, same as the first
L-3 shareholders had better hope L-3 makes even more buybacks this year. Otherwise, 2014 could prove painful. The company is projecting further slippage in sales, with full-year 2014 revenues estimated at no more than $12.1 billion -- another 4% decline. Curiously, however, the company believes it will find a way to squeeze extra profits out of these reduced revenues, and grow its operating margin back up to 10.5%.
That would be a neat trick, but even if L-3 manages to pull it off, an anticipated rise in effective tax rates, to 33%, could end up reducing profits per diluted share to as little as $8.15 per share. Absent further help from buybacks, that could result in an earnings decline of as much as 5% in 2014 -- even worse than what analysts are already expecting.
Given that the analysts already aren't expecting much out of L-3, and are projecting long-term earnings growth of only 2.4% annually, a failure to clear an already low bar could trip up L-3's stock pretty badly.
L-3 Communications isn't a bad stock, but you deserve a better one
There's a huge difference between a good stock and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.