L-3 Communications Gets FMS Contract

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L-3 Communications Holdings Inc. (LLL) has won a $22.6 million U.S. Air Force deal to supply aircrew training systems to the government of Iraq. Work on the contract is slated to be done in Arlington, Texas, through March 2015.

The contract is being administered from the Wright-Patterson Air Force Base under the foreign military sales (“FMS”) program by the Defense Department. Wright-Patt is home to the Air Force Security Assistance and Cooperation Directorate, which oversees foreign military sales.

L-3 Communications Holdings operates through its wholly owned subsidiary, L-3 Communications Corporation. L-3 Communications is a leading supplier of a broad range of products and services used on a number of aerospace and defense platforms. In addition, the company is a prime system contractor for aircraft modernization and maintenance; ISR collection platforms; simulation and training; and government systems support services.

Earlier, in July 2012, L-3 Communications completed the spin-off of 100% of a new, independent, publicly traded government services company – Engility Holdings Inc. (EGL) – to L-3 shareholders. We believe that L-3 Communications has ample opportunity for growth and profit expansion after the favorable conclusion of the spin-off of its Government Services businesses. The company has retained its profitable Cyber, Intelligence, and Security Solutions business. The spin-off also removes a lot of uncertainty with respect to revenue and takes away some of the low margin businesses of the company. Over the longer run, we view the company as one of the best-positioned pure defense players based on its non-platform focus, broad diversification of programs and its focus on shareholder value.

L-3 Communications is strengthening itself by focusing on improvement of operational efficiencies, investing in research and development to provide affordable solutions, acquiring businesses that will add new capabilities, and expanding product lines and divesting businesses. Moreover, its broad diversification of programs would provide growth momentum. Going forward, we expect future growth to come from the company’s strong presence in the current focus areas of C3ISR equipment; precision-guided weapons; unmanned aerial vehicles (“UAVs”); and other electro-mechanical robotic capabilities.

Over the longer run, however, we maintain our Underperform recommendation on the stock. The stock is currently trading at a discount to both the peer group and the S&P 500 based on forward earnings estimates. The discounted valuation is mainly because of the company’s non-platform focus, resulting in shorter cycle contracts, and its prominent position as sub-contractor/supplier to other defense primes. This also results in contracts expiring faster than its peers, bringing in the need of new ones to replace them. However, with domestic contracts drying up fast, the company’s growth will be influenced by its ability to capture new contracts going forward. In the near term, the company is witnessing lower sales while higher competition has resulted in margin headwinds through re-competitions of existing businesses. Thus, we would advise investors to exit from the company for now until the ongoing macro headwinds abate. L-3 Communications currently retains a Zacks #3 Rank, which translates into a short-term Hold rating.

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