Elbit Systems (NASDAQ:ESLT) just may be the biggest defense contractor you've never heard of.
Weighing in at $3.5 billion in market cap, Israel's biggest (U.S.-listed) defense contractor is bigger than American MRAP-maker Oshkosh, and bigger than Oshkosh peer Navistar, robo-warrior iRobot, and drone-maker AeroVironment -- combined. Elbit also just happened to report earnings on Tuesday. Here's how they went:
- Fiscal second-quarter revenues climbed to $750 million, up 7% year over year and outpacing growth rates at most of its U.S. defense contractors.
- Operating profit margins slid 20 basis points, however, to 8.7%.
- This blunted the effect of strong sales growth, holding profits-per-share growth to just 3% -- $1.06 for the quarter.
So in all, it was good news/bad news for Elbit Systems stock last quarter. Now here's some more good news.
In contrast to last year's Q2, in which Elbit ran a free cash flow deficit, burning through more than $78 million, Elbit generated nearly $10 million in positive FCF in this year's second quarter. According to data from S&P Capital IQ, this brings Elbit's total cash haul for the past 12 months to $184 million, which is 9% ahead of reported net income.
Valuation-wise, this means that while Elbit Systems stock sells for nearly 21 times reported GAAP earnings today, the stock costs only 19 times actual free cash flow. With profits growth expected to average nearly 11% annually over the next five years, and a dividend yield of 1.6%, this makes Elbit Systems stock look, if not exactly cheap, then at least a bit less expensive than it would appear when valued on P/E alone.
What comes next
Greeted with all this news, investors appear to have decided it was not good enough and are selling the stock in droves. At last count, Elbit shares were down more than 3% (and still priced a bit high for my comfort).
That seems to me the right call to make, and I'll tell you why:
Although Elbit's strong revenue performance in Q2 was encouraging, and although I'm certainly pleased to see free cash flow take a turn for the positive, the longer-term trend for Elbit appears to be negative. Consider that over the past year, Elbit has reported more than $3 billion in sales and is growing these sales on average at about 3.5% annually (Q2's performance being a bit of an exception).
Meanwhile, backlog has grown only $131 million, to $6.3 billion at last report. That's just 2.1% growth in backlog, a slower pace than revenue has grown. It implies that sales, which already aren't growing all that fast, could slow even more going forward.
I don't believe these anemic growth rates justify Elbit's multiple to FCF of 19, or its multiple to earnings of 21. Investors, selling the stock this week, appear to agree.