Welcome back to Defense Investing 101, Fools.
Last week, we came to the culmination of our investigation into the world of defense investing. We discussed the investment merits of giants like Boeing (NYSE: BA ) and Lockheed Martin (NYSE: LMT ) and found the former wanting, but the latter pretty darn attractive.
But here's the thing: We were looking only at the big companies. Mightn't there be even better opportunities a bit farther down the market cap ladder?
Indeed there might...
No offense to Boeing, Lockheed, and other large-cap defense stocks, but these companies are, generally speaking, old hat. Meanwhile, some of the most innovative and fastest-growing companies in the sector are, well, new hat. Companies you've never heard of before, like Israeli aircraft maker Elbit Systems, or night-vision camera maker FLIRSystems. Or firms you've heard of, but perhaps never knew had a defense angle at all.
Roombas with attitude
Take tiny iRobot (Nasdaq: IRBT ) , for example. You know it as the company that makes the little Frisbee-shaped robots that mop and vacuum the floors of your McMansion. But did you realize that this company also makes robots that disarm bombs, jump through windows, and burrow deep within Osama bin Laden's caves?
iRobot does, and its products do all those things and more.
In search of companies with faster growth and higher profit potential, I've taken the liberty of digging into the financials of a few of these "Davids" of the military-industrial complex, to see how well they stack up against the "Goliaths" we examined last week. Curious to see the results? I won't keep you waiting:
|
Company
|
P/E
|
P/FCF
|
5-year Projected Growth Rate
|
Backlog ($ millions)*
|
|
FLIR Systems (Nasdaq: FLIR )
|
17.1
|
17.2
|
19.3%
|
617
|
|
SAIC (NYSE: SAI )
|
15.3
|
7.5
|
12.1%
|
16,793
|
|
iRobot (Nasdaq: IRBT )
|
109.3
|
13.9
|
24.7%
|
12*
|
|
AeroVironment (Nasdaq: AVAV )
|
23.4
|
29.2
|
20.2%
|
652
|
|
Axsys Tech
|
18.9
|
103.8
|
18.7%
|
162
|
|
Oshkosh
|
n/a
|
1.4
|
13.3%
|
3,334
|
|
Textron (NYSE: TXT )
|
20.8**
|
n/a
|
11.0%
|
21,140
|
P/E and P/FCF data and growth estimates courtesy of finviz.com. Most backlog data courtesy of Capital IQ, a division of Standard & Poor's. *iRobot backlog refers to only the firm's government & industrial (military robots) division. **Textron P/E based on earnings excluding extraordinary items.
These go to 11 -- and beyond ...
Nigel: "Most blokes will be playing at 10 ... Where can you go from there? Nowhere. What we do, is if we need that extra push over the cliff ... 11. One louder."
DiBergi: "Why don’t you just make 10 louder and make 10 be the top number, and make that a little louder?"
Nigel: [Pauses] "These go to 11."
-- From the movie This Is Spinal Tap
The first thing that jumps out at you in the table above is the growth rates. Whereas most of the defense industry giants we examined last week struggle to "play at 10," the slowest of today's tiny giants -- Textron -- goes to 11. The fastest, iRobot, is pushing 25% annual growth.
The need for speed ...
And it's the rip-roaring growth that really sets these companies apart -- and justifies their seemingly pricey P/E ratios. In my view, FLIR Systems tops the list precisely because its growth rate is so much higher than both its P/E and its price-to-free cash flow ratio. This, combined with significant backlog of future work to be done and a balance sheet brimming with more cash than debt, makes FLIR look best set to outperform the market.
Archrival Axsys, by the way, boasts similar-balance sheet strength, and has growth prospects almost as far out as FLIR's. It's the company's lack of significant cash profits that keeps me from endorsing Axsys.
... and why it's hard to race with a handicap
I should also point out why Textron and Oshkosh score so low on this list. Textron's lack of free cash flow plays a large part, of course, as does Oshkosh's failure to earn a P/E ratio. The real knock against these two companies, though, is that each carries way too much debt -- more than three times market cap for Oshkosh, and more than 3.5 times for Textron.
Given my druthers, I'd rather own a pricier but debt-free stock like iRobot or AeroVironment (in fact, I do own AV). That or SAIC, which -- in addition to generating heaps of free cash flow -- carries relatively small amounts of net debt.
Foolish final thought
This column wouldn't be complete without my mentioning the elephant in the room -- or perhaps, the mouse standing next to the elephant. Fact is, size does matter to investors, in that small, hyprgrowth companies like those listed above are constant targets for acquisition by growth-hungry giants.
If you're waiting to profit from a "buyout premium" when iRobot buys a defense major ... well, keep waiting. On the other hand, rumors that Boeing might be interested in purchasing Textron's helicopter business show us that even the biggest of these small fry isn't too big to benefit from a buyout boost.
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