A little more than a week ago, I penned an article citing three stocks on my watchlist, thinking that at least one of them had a good chance of making it into my portfolio. Well today I'm putting one of those stocks to work and playing a little defense in my quest for investing domination.
The business
Elbit Systems
And the technology is cool. Elbit's a major player in everything from aerospace and helmet-mounted systems to lasers and advanced C4I (command, control, communications, computers, and intelligence) systems. Led by CEO and President Joseph Ackerman, who's been with the company since 1982, the company's core operations focus on defense and homeland security and should bring some excellent global exposure to my portfolio.
Three reasons why
De-fense!: Like I mentioned before, countries will always need defense. Yes, economies the world over are hurting, but defense is less susceptible to this as it doesn't necessarily correlate with overall economic conditions; the alternative is simply unacceptable. Most cuts thus far in defense spending are related to personnel, health care, and other similar items. Core defense capabilities are still going to get their due and thanks to higher barriers to entry, it's a tough business to get into.
Go global: Elbit has an extremely diverse customer base in countries all over the world. Diversity like this can help mitigate any cuts or lost contracts from any one customer. The U.S. and Israeli air forces, NATO, EU member governments, and corporate customers like Lockheed Martin
Still growing: Elbit is still a relatively small company, with a market cap just over $2 billion, which means there's still plenty of room for growth. The company has grown revenue at a 16% annualized rate over the past decade. Given its global reach and technological capabilities, I see no reason why it won't continue to grow the business going forward.
What could go wrong
Fire on the mountain: Maybe the most obvious risk here is geopolitical. Israel is a beautiful country (I was lucky enough to visit five years ago), but it's a very volatile one as well. Political and religious disputes, violence and upheaval can create a tough work environment and this cannot be ignored.
Putting the pieces together: While Elbit is still relatively small, its stated growth strategy includes continued mergers and acquisitions on both domestic and international fronts. Any trouble integrating acquisitions into the system could be a costly hit to returns.
Penny pinching: There is of course also the risk that countries end up cutting defense spending more, limiting the company's growth. If it looked like Elbit was losing contracts or failing to renew business, we might need to think about looking elsewhere.
Valuation
I've looked at this from a few different perspectives. Currently, Elbit trades for 12.2 times trailing earnings and an EV/EBITDA of 7.4. Historically speaking, if we go back 10 years, it has averaged more than 18 times earnings and an EV/EBITDA of 8. Using relatively modest growth assumptions (much lower than the annualized 16% over the past decade) and a slightly improving operating margin over time, I think shares today are worth closer to $58-$60. Looking forward five years, I can see shares being worth at least $90 representing 12% annualized gains or better from today's price. It's also worth noting that the company pays a modest dividend which currently yields about 2.8%.
Time to make a stand
It's about time I got some defense in the portfolio. I searched high and low to find a company with attractive growth prospects and plenty of global exposure and I think I've found it in Elbit Systems. Given the nature of defense and the fact that this may be my only exposure to the sector, I am allocating 6% of my capital ($1,000) to this idea. You can drop by my discussion board anytime to talk about this or any of the other companies in my portfolio. Better yet, click here and follow me on Twitter.
