With earnings out of the way, what's next for Raytheon? Image source: Getty Images.
In a week of strong earnings reports from American defense contractors, Raytheon's (RTN +0.00%) report was stronger than most. Quarterly earnings at the rocket maker surged 44% year over year. Free cash flow for the first half of the year was nearly triple what the company generated in H1 2015. And profit margins -- up nearly five full percentage points year over year -- were well above anything seen in recent memory, according to data from S&P Global Market Intelligence.
Can Raytheon keep up this superb performance? To gather some clues, we listened in on Raytheon's post-earnings conference call. Here are five things they told us that we thought you'd like to know.
Thing 1: At this defense contractor, everything's going great guns
Given our performance in 2016 to date, and how we're seeing the balance of the year playing out, we're raising our EPS and cash flow guidance for the year. Further, based on strong demand that we're seeing from our global customers, we also have raised our outlook for bookings. -- Tom Kennedy, CEO
As further explained by company CFO Toby O'Brian, Raytheon sees no real movement in its sale projections for this year, and continues to expect to see only low-single-digit sales growth, and full-year revenues of $24 billion to $24.5 billion.
That said, the profitability of Raytheon's revenues is improving -- by about 20 basis points. Accordingly, management now expects to earn operating profit margins of between 13.2% and 13.4% this year, resulting in a $0.20 improvement in earnings, which are now estimated to be between $7.13 and $7.33. Cash flow is also improving, to the point where the company now expects to generate between $2.8 billion and $3.1 billion for the year.
With Raytheon tracking toward $500 million in annual capital spending, that should work out to free cash flow of between $2.3 billion and $2.6 billion -- as much as a 33% leap from 2015 FCF, and quite possibly the company's most cash-rich year ever.
But how?
Thing 2: In-demand products
During the second quarter, I visited a number of country leaders in the Asia-Pacific region. ... There was a remarkable level of consistency among these conversations. That is customers are interested in capabilities to address two key missions, one, support global counterterrorism campaigns, and two, maintain deterrence in a charged geopolitical environment. More specifically, we continue to see strong demand for integrated air missile defense solutions, precision munitions, and C5 ISR capability. This demand has been broad-based across the European, MENA, and Asia-Pacific regions." -- Kennedy
Simply put, Raytheon is seeing strong demand from its customers around the world for the very products that it specializes in. This isn't simply a case of some "arms dealer" pushing its products on the world, but of world leaders seeking out Raytheon to fulfill a perceived need for national defense.
Thing 3: We need it, and we need it now
Further, this year there's been an added sense of urgency. I can't think of a time when our international pipeline of opportunities was more robust than it is today. Our international model which looks at countries as markets, is paying off.
-- Kennedy
Strong global demand for defense products is driving Raytheon's sales growth. At the same time, the company is continuing to grow the profit margins on its products. How? Well, this comment from Mr. Kennedy gives one clue.
The buyers Raytheon is selling to are motivated buyers, driven to purchase missiles, and missile defense systems, out of a "sense of urgency." It almost goes without saying that panicked buyers aren't in the best position to comparison shop between competing systems, or to engage in long and drawn-out negotiations in price. All that adds up to improved profit margins for Raytheon.
Thus, Raytheon's international business is booming. But what about in the U.S.?
Thing 4: Meanwhile, back at the ranch ...
I'd like to take a moment to briefly touch on the FY '17's defense budget. As most of you know, both the House and Senate have marked up their respective bills, and there are significant differences between them. These differences will need to be reconciled before the budget is finalized. Given this, and the fact that it is an election year, we're anticipating that there will be another continuing resolution which will probably extend beyond the election in November. This assumption is considered within our financial guidance range. -- Kennedy
Here at the Fool, we've given a lot of thought to the competing Presidential candidates, and how their policies might affect the U.S. defense budget. In the short term, at least, Raytheon doesn't seem to be worrying about this.
Eventually, the election will end. Someone will win, and someone else will lose. In the meantime, Raytheon sees little risk to defense spending, even in the absence of a defense budget, as Congress will tide the contractors over with a continuing resolution to maintain spending. And after the budget is passed, and after that, when a new president moves into the Oval Office?
Call me a crazy optimist, but judging from experience, defense spending just isn't likely to decline.
Thing 5: Cautious optimism (emphasis on "cautious")
So we had planned and we front loaded the share repurchase based upon the timing of our cash flows, OK? And ... at our last call, we indicated a target of 80% to 90% of free cash flow going back to shareholders. Right now, we probably see it maybe at the bottom of that range pending market conditions, and if we continue to see strong movement in the stock, we're not going to chase the stock price. Share repurchase will still continue to be a core part of our capital deployment strategy ... but we will continue to be disciplined when it comes to the allocation of our capital. -- Toby O'Brian, CFO
Questioned by analysts on why Raytheon appeared to have reduced the rate at which it was buying back shares, CFO O'Brian responded with the above blunt assessment, and it's one that should resonate with investors.
Raytheon's stock is a good one, its market is growing, and its prospects look bright. Raytheon's stock certainly is worth buying at some certain price -- but not at any price. Accordingly, as the stock goes up -- and Raytheon's is up 30% over the past year -- Raytheon's spending on share buybacks will go down.
Even in light of all the good news that Raytheon announced last week, that's a lesson investors might want to learn from, as well.
