Should Raytheon Raise Its Dividend?

Shares of Raytheon (RTN +0.00%) have climbed 29% so far this year, giving investors in the company little reason to complain. But one side-product of the soaring stock price is a rather pedestrian 1.64% dividend yield. Given the company's suddenly inflated valuation, trading at more than 25 times trailing 12-month earnings for the first time in recent history, does Raytheon need a dividend boost to entice new investors and keep the rally going?

An aerial view of the Pentagon. Image source: Getty Images.

Raytheon dividend snapshot

DATA SOURCE: YAHOO! FINANCE. LAST INCREASE REFERS TO EX-DIVIDEND DATE.

A history of hikes

Raytheon has a solid history of dividend increases, last March raising its quarterly payout by 8.9% to 79.75 cents per share. The move was the 13th consecutive year the company has increased its dividend, putting the company just behind the 14-year streaks boasted by rivals Lockheed Martin and Northrop Grumman.

Just 10 years ago, in 2007, Raytheon paid a quarterly dividend that maxed out at 25.5 cents per share. During that time the company has also reduced its share count by nearly 30% via share repurchases.

Alas the stock run-up has had the effect of masking some of that standout dividend work. The company's dividend yield has fallen steadily from a high of more than 4% in late 2011 to a current 1.64% largely because its share price has nearly tripled in just the last three years. That stock appreciation is an argument for using available cash to further hike the dividend: Given the increased share price, the company would presumably be better-served by increasing the payout rather than continuing to aggressively repurchase shares.

RTN Average Diluted Shares Outstanding (Quarterly) data by YCharts

Financial strength...

Raytheon seemingly has the wherewithal to increase the dividend should it choose. The company's payout is currently about 42% of earnings. And after a first-quarter hiccup where Raytheon actually consumed $127 million in cash, it returned to free cash flow positive in the second quarter, with execs guiding investors to expect cash flow to accelerate in the second half of this year due to program milestones and deliveries.

The outlook for the company is strong. Analyst consensus expects Raytheon to earn $7.59 per share in 2017, up from $7.44 full-year earnings per share in 2016, and current 2018 consensus forecast is for another 11.7% jump to $8.48 per share in earnings.

That said, despite Raytheon's impressive track record of raising the dividend the company rarely does two boosts in a single year. And management does not seem likely to change course on a dime. The defense business often involves projects that span multiple years from initial order to delivery, and the Pentagon tends to encourage conservative, fiscally prudent activity from its contractors.

... But dueling priorities 

Management might also be wise to keep some dry powder in case it sees an attractive expansion opportunity. Raytheon in recent years has sought to return about 80% of free cash to shareholders, putting the rest toward internal investment and M&A. Defense M&A has been front-of-mind of late, as Northrop Grumman in September agreed to acquire Orbital ATK for $7.8 billion. At times one large deal in a sector can be a spark that pushes other companies to the altar.

CEO Thomas K. Kennedy during the company's second-quarter earnings call in late July said "right now the focus definitely is on growth and expansion," when it comes to cash deployment, though he did say he found the properties on the market to be overpriced.

"We haven't seen anything attractive," Kennedy said. "But if there is something out there that makes sense, we always look at them and determine whether it's the best value for us and, obviously, our shareholders."

The bottom line

So will investors be treated to a dividend boost? It seems very likely that Raytheon will hike its payout next spring, following the company's well-established pattern. It is even possible that if management feels confident about its 2018 outlook, the annual increase could be a bit higher than years past in an attempt to make that yield seem more attractive.

But there is little reason for the company to move before next spring. Current Raytheon holders should be content with the run-up in share price they have enjoyed in recent years, and given Raytheon's present valuation a modest surprise hike likely wouldn't attract much new interest in the shares.