Three months ago, defense contractor Raytheon (NYSE:RTN) regaled us with the tale of how, through a combination of share buybacks and improved margins, it managed to transform 11% sales growth into 21% better profits. It hardly seemed fair to ask the defense contractor to repeat that success.

And yet, Raytheon did it anyway -- in spades.

But for naught
Raytheon not only repeated last quarter's feat last week, but bested it. Second-quarter 2008 sales again expanded 11%. Profits from continuing operations soared 27% to $1 per share (the net, however, which was plumped last year by a fat gain on sale of Raytheon Aircraft to Goldman Sachs (NYSE:GS), declined this year). Result: Just as in April, investors shrugged off the news, selling off Raytheon stock by a fraction of a percent.

Investors "ignoring" good news from Raytheon once could have been a fluke. But twice in a row gets my suspicions up. When you consider that in between the back-to-back post-earnings disses, Raytheon's stock has slumped 13% -- there's something going on here. So just what do investors have against Raytheon?

Raytheon's risks revealed
Allow me to pull a couple of quotes from my April column: "Management ... reiterated its previous full-year forecast ... as CEO William Swanson later clarified on the conference call, Raytheon is ... waiting to see what Congress does with its supplemental defense budget before promising business that Raytheon may not receive."

My hunch is that investors watching new bookings are not convinced that Raytheon can sustain its sales growth. Funded backlog is up only 8% year over year; the situation with total backlog is even worse -- up a bare 2%. Both numbers suggest that Raytheon may be hard-pressed to maintain an 11% growth rate much longer.

Rudder hard a-port
But if that's what's worrying investors, I think they may be overreacting. While backlog isn't growing as fast as sales right now, Raytheon's doing a whole lot better than it has in years past. Why, the numbers even suggest an honest-to-goodness turnaround is taking place. Consider:


Q1 06

Q2 06

Q3 06

Q4 06

Q1 07

Q2 07

Q3 07

Q4 07

Q1 08

Total backlog (in billions)










Funded backlog (in billions)










And now here we are at the end of fiscal Q2 2008, and Raytheon has a tidy $37.5 billion in total backlog and $22.2 billion in funded backlog. Sure, that's a small sequential decline (on both counts). But year over year, the company's still growing its order book. What's more, this marks the third quarter in a row in which the year-over-year comparison shows a rising backlog. When viewed against the backdrop of the first three quarters of last year, that's an impressive turnaround.

Shoals ahead?
A related risk, however, surfaced just last week. The U.S. Navy confirmed that because of cost overruns at its new Zumwalt destroyer program ("DDG-1000"), it wants to scuttle the program after General Dynamics (NYSE:GD) and Northrop Grumman (NYSE:NOC) finish building the first two ships. Instead of more DDG-1000s, the Navy intends to order eight cheaper DDG-51 Arleigh Burke class destroyers.

The fear here is that because Raytheon was building the electronic "innards" for the Zumwalt's radar and missile systems, terminating the program will dry up a lot of potential revenue, shifting it to Lockheed Martin (NYSE:LMT), which makes much of the guts for the DDG-51.

Not so, says Raytheon's CEO. For one thing, Raytheon also builds electronics for the Arleigh Burke class, and so it should profit no matter which ship the Navy ultimately orders. For another, the Navy's unlikely to throw away the more advanced Raytheon technology developed for the Zumwalt -- it's more likely to be incorporated into upgraded DDG-51s, if they're built, or future ships ordered for the Navy.

Finally, let's not forget the political element. A lot of contractors have their fingers in Admiral Zumwalt's pie; in addition to those already named, there’s BAE Systems, L-3 Communications (NYSE:LLL), and even Boeing (NYSE:BA). Led by Sen. Edward Kennedy from Raytheon's home state of Massachusetts, you can bet that if there's an argument to be made for saving the Zumwalt, they'll make it.

Foolish takeaway
So to sum up the "buy thesis" on this one: Raytheon's backlog isn't burning any barns, but after a long year of stagnation in 2007, it's finally trending upward. The cancellation of the Zumwalt program, while a disappointment if it happens (and it may not), won't be fatal to that trend.

Meanwhile, based on current guidance, Raytheon sells for no more than 15 times this year's earnings, and its price-to-free cash flow ratio is even more enticing at 12. Weighed against analyst expectations of 13% annual profits growth, the stock looks to me at worst fairly priced, and perhaps even cheap.

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Fool contributor Rich Smith owns shares of Boeing. The Motley Fool has a disclosure policy.