At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.
And speaking of the worst ...
In Washington, debates rage over whether to jump over the fiscal cliff -- or, perhaps worse, to attack the deficit with an ax instead of a scalpel, inflicting indiscriminate cuts on the social safety net and defense programs. This has a lot of people worried that defense contractors will suffer in either scenario.
Many people, but apparently not Goldman Sachs.
To the contrary, on Friday, Goldman sounded the all-clear on one such defense contractor -- Alliant Techsystems (NYSE: ATK). Alliant's had a rough couple of years, sure -- losing the contract to run military ammunition manufacturing in Radford, Va., suffering lost revenues from the Ares 1 rocket program, and enduring defense spending cuts more generally. But as StreetInsider.com reported Friday, Goldman now views all of these challenges as being "in the rear mirror." Looking forward, Goldman sees a company whose defense expectations have been "reset," whose commercial businesses have "upside surprise potential," and whose stock is just cheap enough that it might become an acquisition target.
Dial "M" for "merger"
That last comment is of particular interest. Eras of declining defense spending are, after all, historically good times to expect mergers and consolidation, as "squeezed" companies try to replenish evaporating revenue streams with the revenues of their former competitors. In fact, the firm that stole the Radford contract from Alliant last year, BAE Systems, tried to do a merger of its own a few months ago when it broached the idea of tying up with fellow defense contractor EADS. That merger failed, but I'll bet it got a lot of BAE's rivals thinking about doing mergers of their own.
Who might buy Alliant? The answer probably depends on what you think Alliant is. Because honestly, this company does it all, manufacturing everything from bombs to bullets to rocket engines. (That's right. These guys are literal rocket scientists.)
Viewed as a bullet-baker, the company's arguably a good partner for a guns company like Smith & Wesson (SWHC 1.31%) or Sturm, Ruger (RGR 2.20%), both of whose stocks are now flush on post-election expectations of a surge in gun buying from a panicked public. But given the relative size of the companies, Alliant's more likely to buy itself a gunmaker than the other way around.
On the other hand, Alliant's role in defense contracting -- plus its role in building rocket engines -- makes its acquisition by a company with a hand in both industries even more attractive. Here, Boeing (BA 1.98%) and Lockheed Martin (LMT 1.83%) are the logical candidates.
Valuation matters
The bigger question, though, is whether anyone should buy Alliant -- Boeing, Lockheed, or ... you. Simply put, does the valuation work?
For most investors, I rather suspect it will not look attractive. Sure, Goldman's right that the stock looks "cheap" at a valuation of eight times earnings. It looks just as cheap when valued on its free cash flow, which backs up more than 99% of reported net income. But the problem isn't what Alliant's income is today, but rather what it will be tomorrow. (Figuratively speaking).
You see, earnings at Alliant declined in the firm's report earlier this month. They've been falling for two straight years in fact, and are expected to drop again next year -- which explains why the company's forward P/E ratio of 8.5 is higher than its trailing P/E ratio. The situation's not changing anytime soon, either, with most analysts predicting Alliant shareholders have five years of average 3% annual declines in profit to look forward to.
Foolish final thought
In contrast, both Boeing and Lockheed Martin are expected to post modest, but on the whole steady, increases in earnings over the next five years.
That's not to say they won't buy Alliant Techsystems anyway. The stock sports low price-to-sales and price-to-EBITDA ratios; both are cheaper than the corresponding ratios at Boeing and Lockheed. Hence, Alliant's stock may look attractive as a target for either of its rivals to acquire. The more so because, as its new owners, Boeing or Lockheed would have the power to stabilize the company's earnings declines by cutting costs, laying off workers, raiding the pension fund, and so on and so on.
The key point to remember, though, is that they have this power. You don't, and if a buyout never happens, you're basically stuck owning Alliant as is -- high debt levels and poor growth prospects included. Result: A bet on Alliant is a bet on someone else coming along and making the company better than it currently is.
