I recently wrote an article that compared the relative cheapness of the defense sector with the overall market, and I found the entire sector selling at 24% less than the market. As part of that article, I promised to dig past the overall industry numbers and to analyze some specific stocks I highlighted as potential buy targets.

In keeping my word, I present a foray into a specific defense stock: Alliant Techsystems (NYSE: ATK). In analyzing the company, I'll look at its long-term business model, financial standing, management strength, and current valuation to see whether the company seems appealing.

What it does
Spun off from Honeywell in 1990, Alliant Techsystems operates a diversified but interrelated host of businesses. For instance, it works closely with NASA, for whom it builds the reusable rockets that NASA's space shuttles use to fly their missions. And it also holds the title of world's largest manufacturer of bullets. The business lines clearly differ, but they complement each other well: Selling interrelated product lines, like bullets and missiles, allows Alliant to serve as a one-stop-shop for all things that go boom.

Alliant operated under three distinct segments during fiscal 2010: Armament Systems, Mission Systems, and Space Systems. Here's the segment breakdown for 2010.

Segment Name

% of Total Revenue

Total Revenue Amount (in $M)

Operating Margin

Armament Systems




Mission Systems




Space Systems




Data courtesy of Capital IQ, a division of Standard & Poor's, as of most recent 10-K.

When you see "Armament Systems," think bullets and explosives. This segment's work ranges from the bullets a sport shooter fires at the range on the weekends to the shells that tanks direon the front lines of battlefields the world over. This segment also derives a significant portion of its revenue from contracts with the federal government to operate several munitions plants throughout the United States.

The Mission Systems division produces big-ticket defense equipment such as aircraft components, rocket equipment, missile-defense systems, and large-caliber tank ammunition.

The Space Systems portion manufactures rocket motor systems for human and cargo launch vehicles, missiles, missile-defense interceptors, and satellites.

The breakdown of Alliant's customer base suggests a diversification that I like:

Customer Name

% of Sales

Commercial/International 31%
U.S. Army 28%
NASA 18%
U.S. Navy 11%
U.S. Air Force 7%
Other U.S. Government 5%

Although certainly government-tilted, the company has a clear ability to sell to other parties (on a consumer and international level), and that advantage should help cushion its earnings from Congress' budget decisions.

Financial performance
Over the past 10 years, Alliant produced an average return on equity of 31.51%. Throughout the past decade, it never dipped below 19%, with the 2009 annual figure of 19.8% representing its lowest level.

But don't get excited too quickly. A look at the balance sheet reveals exactly how the company manages to produce such impressive returns: by employing a significant amount of financial leverage. During fiscal 2010, the company maintained a debt-to-equity ratio of 1.73, or almost twice the level of borrowed money to that of contributed capital. That's pretty consistent within the business strategy: Over the past decade, Alliant maintained an average debt-to-equity ratio of 1.99.

For a conservative investor, this signals a major red flag. Too heavy a debt load can force even the best-run companies into the ground. But at the same time, it probably deserves mentioning that Alliant managed to operate successfully during the past decade without nearing default.

Management assessment
Managers drive their businesses by deciding the best uses of their companies' capital. In looking at Alliant's track record, I like what I see. The company has consistently grown through a series of sensible acquisitions, and it has shown discipline by purchasing only companies with similar or complimentary product lines. In this light, management seems more than capable.

I also like to see that a company's management owns a meaningful stake in the company. Aligning management's interests with that of its shareholders keeps it focused on delivering results for the company's owners. In Alliant's case, no key officer owns a meaningful chunk of the company, though some do have decent-sized holdings in an absolute sense.

Although this situation does make the company's stock less attractive, it isn't necessarily a deal-breaker. Skilled and committed managers will work hard to deliver results regardless of how much of their company they own. However, I do always feel more comfortable knowing that management will feel the same sting as investors do should something go awry.

I think Alliant Techsystems seems like an attractive investment opportunity. Over the past decade, the company has traded at an average P/E multiple of 18. Given that the company currently trades at 8.1 times earnings, less than 50% of its decade-long P/E, the risk-reward situation seems compelling, especially considering that larger competitors Northrop Grumman (NYSE: NOC), Raytheon (NYSE: RTN), and Lockheed Martin (NYSE: LMT) trade at 9.8, 10.9, and 11.2 times earnings, respectively.

In fact, one prominent member of the investing community also likes Alliant's investment potential: First Eagle Funds, the family of funds run by value investing legend Jean-Marie Eveillard, owns 10% of the company. Not that this will influence an investment decision, but it certainly does give a little credence to this investment thesis. At any rate, paying a bottom-barrel price for a quality business, albeit one facing some headwinds, can richly reward intrepid investors.

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