Foolish Forecast: Riding Herd on Raytheon

'Tis the season for earnings reports, and in particular, for defense contractors. All the big names are coming out with their Q3 news -- United Technologies (NYSE: UTX) and Textron (NYSE: TXT) reported last week. Lockheed Martin (NYSE: LMT) reported yesterday, followed by Northrop Grumman (NYSE: NOC), Boeing (NYSE: BA), and General Dynamics (NYSE: GD) today.

It all happens so fast, a Fool barely has time to take notice of the earnings, much less make sense of them. But we're doing our best to put the news in context for you. Speaking of which, here's what you'll want to know about Raytheon (NYSE: RTN) before it reports on Thursday.

What analysts say:

• Buy, sell, or waffle? Twenty analysts follow Raytheon. Ten of them think you should buy the stock, nine say to hold, and one votes sell.
• Revenues. On average, they expect to see quarterly sales rise 8% to $5.34 billion.
• Earnings. Profits are predicted to climb 12% to $0.81 per share.

What management says:
CEO William Swanson pronounced himself "very pleased" with Raytheon's performance in the first half of this year. Reviewing the second quarter's numbers, he credited "strong operational improvements" with helping to translate 9% sales growth into 30% earnings-per-share growth, permitting management to raise guidance for the full year. (New guidance is for $3.05 to $3.20 per share in profit earned on $21.4 billion to $21.9 billion in revenues.) Operating margin was up 150 basis points year over year in the first half, as operating expenses grew more slowly than sales by about a third.

What management does:
Gross and operating margins continue to gain altitude at Raytheon, and the firm's rolling net margin currently sits nearly twice as high as it did one year ago. Don't get too excited by that net number, however. It's derived almost entirely from the fact that Raytheon enjoyed a nearly $1 billion gain on its sale of the Raytheon Aircraft Company. By definition, those earnings are now in the past (although they'll continue to inflate the rolling tally on the net for three more quarters).

Margins	3/06	6/06	9/06	12/06	3/07	6/07
Gross	17.4%	17.9%	18.4%	18.4%	18.6%	18.9%
Operating	8.5%	8.9%	9.4%	9.3%	9.6%	10.0%
Net	5.3%	6.0%	6.4%	6.3%	6.5%	11.3%

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
Raytheon's cash flow picture is a bit less attractive, at least for the time being. So far this year, Raytheon's operating cash flows from continuing operation are in the red. For that, you can thank: (1) the taxman, who arrived with his hand out this year, levying $643 million in taxes; and (2) Raytheon's pension fund, into which the company injected $400 million during Q1.

Thanks to these payments, management had to ratchet down its free cash flow expectations for the year. These now center on about $1 billion in operating cash flow. The company normally spends about $300 million per year in capital expenses, so we're probably looking at about $700 million in free cash flow this year. Valuation-wise, that puts Raytheon's price-to-free cash flow ratio at about 40 -- nearly twice where it would be without the unusual tax and pension charges. Something to keep in mind for Fools attracted by this company's current low PEG ratio.

Interested in Raytheon? Read about its plans to protect airliners from terrorists in:

• Protecting Unfriendly Skies
• Raytheon: Defense on the Cheap