Raytheon Company (NYSE: RTN) is the fourth largest U.S. defense contractor ($24.88 billion in revenue in 2009) and has a diverse business mix of attractive products with a focus in electronics. The company specializes in manufacturing radars and elector-optical sensors (airborne, naval and ground based), missiles, satellite sensors, radios and digital communication systems, and missile defense. Raytheon diversifies in smaller subcontracts and relies on international contracts more than any of its competitors. Some of its better known contracts include the DDG - 1000 (a Navy Destroyer model), the Tomahawk Cruise Missile, and the Patriot Missile.
Since the terrorist attacks of September 11, the price of Raytheon stock has been on a steady march upward. The company has benefited from the increased government spending on military technology that has accompanied a period of rising geopolitical conflict. The United States government is Raytheon's principal customer, accounting for nearly 80% of total sales. Such heavy reliance on one source for income is softened by the company's strong diversification in small contracts; the loss of one program would not significantly affect the company's business. However, Raytheon is still not immune to political changes. Traditionally, Raytheon has preferred Republican political victories since a Republic-led government has led to increased defense spending. The U.S. government continues to amplify its involvement in defense spending, creating a steady flow of income for Raytheon. Building high-tech weapon and electronics systems is an industry that few can compete in, creating a significant competitive moat for Raytheon and its competitors. Furthermore, it is in the U.S. government's interest to ensure that each of its contractors turns a profit and produces at the highest technological level, compelling the government to send plenty of contracts Raytheon's way.
In October 2009, the Company acquired BBN Technologies Corp. and related entities.
Second Quarter 2010 Results
Raytheon announced second quarter 2010 adjusted EPS of $1.36 per diluted share, compared to $1.22 per diluted share in the second quarter 2009. Second quarter 2010 income from continuing operations attributable to Raytheon was $0.56 per diluted share compared to $1.24 per diluted share in the second quarter 2009. Net sales for the quarter were $6.0 billion. Net sales in the second quarter 2009 were $6.1 billion.
Second quarter 2010 income from continuing operations attributable to Raytheon included a ($395) million before-tax unfavorable adjustment, ($274) million after-tax or ($0.71) per diluted share, due to the previously announced program termination notice received by Raytheon Systems Limited on July 22, 2010 from the UK Border Agency.
IDS provides integrated solutions to an international and domestic customer base. IDS leverages its knowledge and capabilities in sensors, command, control and communication (C3), effects and mission support, to provide integrated naval, air and missile defense and civil security response solutions. Its major domestic customers include the United States Navy, Army and Air Force, and the United States Missile Defense Agency (MDA). Its major international customers include Japan, Saudi Arabia, United Arab Emirates, Taiwan, Australia, Germany, Korea and Finland. IDS’s principal product lines include Seapower Capability Systems (SCS), National and Theater Security Programs (NTSP), Patriot Programs (PP), Civil Security and Response Programs (CSRP), Global Business Operations (GBO) and Intelligence and Information Systems (IIS).
IIS is a provider of intelligence and information solutions specializing in ground processing, unmanned ground systems, cybersecurity solutions, homeland/civil security and other markets. Approximately half of its business is for classified customers. Other customers include the United States Intelligence Community, United States Department of Defense (DoD) agencies, the Federal Bureau of Investigations (FBI), the National Oceanographic and Atmospheric Association (NOAA) and the United Kingdom Home Office. During 2009, IIS reorganized its business operations, and as a result, it operates under the six product lines serving customers, including intelligence, surveillance and reconnaissance (ISR), DoD/civil space, intelligence operations support, cybersecurity, environmental solutions and civil security. IIS’s principal product lines include Mission Operations Solutions (MOS), Operational Technologies and Solutions (OTS), Ground Enterprise Solutions (GES), Defense and Civil Mission Solutions (DCMS), Information Security Solutions (ISS) and Advanced Programs.
MS is a developer and producer of missile systems for the armed forces of the United States and other allied nations. MS develops and supports a range of cutting edge weapon systems, including missiles, smart munitions, close in weapons systems, projectiles, kinetic kill vehicles and directed energy effectors. Its customers include the United States Navy, Army, Air Force and Marine Corps, the MDA and the armed forces of more than 40 allied nations. MS’ principal product lines include Naval Weapon Systems (NWS), Air Warfare Systems (AWS), Land Combat and Exoatmospheric Kill Vehicle (EKV).
NCS is a provider of net-centric mission solutions for government and civil customers. NCS leverages its capabilities in networking, command and control, and communications to develop and produce solutions for customers, including the United States Army, Air Force, Navy and Marine Corps and other government customers, as well as numerous international customers. Raytheon BBN Technologies is a research partner with the DoD and a provider of solutions for national defense and security missions, such as the Wireless Network After Next (WNaN) program. Raytheon BBN Technologies also provides Boomerang, a deployed sniper detection system that provides real-time target directions to combat teams. NCS’ principal product lines include Combat Systems (CS), Integrated Communications Systems (ICS), Command and Control Systems (C2S), Thales-Raytheon Systems, LLC (TRS) and Operations and Precision Components (OPC).
SAS is engaged in the design and development of integrated systems and solutions for advanced missions, including traditional and non-traditional intelligence, surveillance and reconnaissance (ISR), precision engagement, unmanned aerial operations and space. SAS provides electro-optical/infrared sensors, airborne radars for surveillance and fire control applications, lasers, precision guidance systems, processors, electronic warfare systems and space-qualified systems for civil and military applications. Its customers include the United States Navy, Air Force and Army, as well as classified and international customers. SAS’ principal product lines includes Tactical Airborne Systems (TAS), Intelligence, Surveillance and Reconnaissance Systems (ISRS) and Space Systems (SS).
TS provides a spectrum of technical, scientific and professional services to defense, federal, international and commercial customers worldwide. It specializes in training, logistics, engineering services, product support and operational support services. TS provides solutions for mission support, homeland security, space, civil aviation, counterproliferation and counterterrorism markets. Its customers include all branches of the United States Armed Forces, as well as the DHS, NASA, FAA, Department of Energy, Defense Threat Reduction Agency (DTRA) and international governments. TS’ principal product lines include Integrated Support Solutions (ISS), Customized Engineering & Depot Support (CEDS), Warfighter FOCUS, Raytheon Professional Services (RPS) and Raytheon Polar Services.
Roughly 78% of Raytheon's revenue comes from the U.S. government. Broken down by military branch, the company is well diversified, with the Navy accounting for 25% of sales, the Army 20%, the Air Force 15%, and other government defense programs representing 17% of sales. Raytheon has facilitated a push by the military branches to be more agile and networked this push by expanding upon its four established areas of expertise: Homeland Security, Missile Defense, Precision Engagement, and Intelligence, Surveillance, & Reconnaissance.
As a leader in missile detection and guidance technology, Raytheon has cemented itself as a key player in developing a ballistic missile defense system for the United States and its allies. With extensive experience in developing precision munitions, missiles, radar systems, and other sensors, Raytheon continues to win contracts in the thousands of smaller programs that combine to form the bulk of the company's business. Cuts in large programs like the production of the F/A-22 have little impact on Raytheon due to its highly limited and specific role in large programs and strong diversification in smaller programs, such as the TOW program which contracts Raytheon to manufacture anti-armor missile weapon systems for Army vehicles.
Foreign governments, particularly U.S. allies, generate approximately 18% of Raytheon's revenue, giving the company the greatest exposure to international sales compared to its peers. Some sectors of the company's business sell more to international customers than others, with missile systems accounting for the bulk of international business. The AMRAAM missile, for example, is a beyond visual range air-to-air missile developed in the 90s that goes on the F-15, F-16, F-18, and several European fighters and generates a significant portion of its revenue abroad.
Recent large orders from Pakistan, Taiwan, Poland, and Chile should help revenue growth of the missile in upcoming years, despite its association with the diminishing F/A-22 fighter program. Furthermore, the Saudi Border Security program and E-Borders in U.K. should be the largest opportunities as the company enters the final stages of the selection process for creating a system that analyzes passenger and crew data of incoming and outgoing travelers (E-borders) and a border security system equipped with radars and surveillance aircraft (Saudi).
Commercial programs constitute 5% of the company's sales. Raytheon specializes in systems engineering work on satellites and other technical services involving electronics and security.
With the bulk of the company's business coming from contracts awarded by the U.S. government, Raytheon's revenues are heavily affected by changes in government defense spending and any turbulence in the company's relationship with the government. Even though no program accounts for more than 4% of total sales--making Raytheon the least vertically aligned of its peers--a general decline in the government's defense budget would surely impact many of the company's programs. Looking ahead, defense spending could flatten out due to pressures from a mounting federal deficit and the eventual withdrawal of troops from Iraq and Afghanistan. Furthermore, the government reserves the right to cut or eliminate any of Raytheon's programs at any time, especially if the program is under-performing or in violation of an agreement. Nonetheless, an arms race with Russia, North Korea or any other U.S. adversary, the perpetual modernization of the military, and the continuing presence of the U.S. in foreign nations will have a positive impact on revenues.
More so than any of its peers, Raytheon depends on foreign government contracts and the appropriate handling of their complexities. A variety of factors must be taken into consideration when the company does business abroad and each of these factors could negatively impact revenues if not properly addressed:
Conversely, smooth handling of the complexities combined with any military build up or conflict for U.S. allies, with all other factors held constant, yields an increase in the company's revenues.
Raytheon has generous pension plans covering the majority of its employees, including certain employees in foreign countries. As the life-expectancy of its employees increases, health care costs rise, and the baby boomer generation begins to retire in bulk, Raytheon must continually adjust its pension plan payment expectations, negatively affecting company revenue. In the last four years alone, the company has averaged $350 million in adjustments each year for the worse. Furthermore, as much of the company's pension funds are in risk free investments, declining interest rates will lower the return on the company's investment and increase its pension costs. Increasing interest rates, however, will lower its pension costs.
Because Raytheon takes part in a highly technologically driven industry, its ability to predict and adapt to ever-changing market demands has a tremendous impact on the number of contracts it will win. The company's future performance depends heavily on Raytheon identifying emerging technological trends, developing and maintaining competitive products and services that distinguish Raytheon from its competitors, developing, manufacturing and bringing products to market quickly at cost-effective prices, and making strategic alliances and acquisitions that will better position the company in its industry. The company's well-established presence as a top-five player in defense contracts suggests that Raytheon will continue to adapt to its surroundings and win the contracts it eyes.
Raytheon and competitors in the defense and aerospace industry are blessed by unusually high barriers of entry, thus limiting the number of major defense contractors eligible to obtain market presence similar to Raytheon. The company has a superb reputation when it comes to innovations and meeting contract expectations and more, which positions Raytheon to win the smaller, subcontracting deals. Raytheon's top competitors include:
To the highest degree amongst its competitors, Raytheon mitigates its dependence on individual programs by competing as a subcontractor to puts its subsystems on full-scale systems like aircrafts, ships, and vehicles. Of Raytheon's 14,000 contracts, which are about equally divided between cost-plus and fixed-price deals, no single contract accounts for more than 4% of total sales. Raytheon competes primarily with General Dynamics on these smaller systems, while Lockheed Martin, Boeing, and Northrop Grumman use their greater capacity to compete to win the fewer, more lucrative contracts for full-scale systems. The Pentagon could be shifting away from the LSI (Lead System Integrator) concept that caused the company to lose some of its market share to competitors in the 1990s, allowing Raytheon to reclaim much of this lost business.
In addition, international sales comprise a greater percentage of Raytheon's revenue than any of its competitors, yielding upswings for the company during tumultuous times for foreign countries like those in Asia and the Middle East with increasing cash reserves.
The recent selling of its under-performing aircraft division leaves Raytheon with no net debt and greater balance sheet flexibility than many of its peers.