• Beat earnings, revenue, backlog and margin expectations in their most recent quarterly report?
• Boasts a PE ratio of less than 10x trailing EPS, well below the 20x and 30x multiple typical of a few years ago, when growth prospects were as solid as they are in the near future?
• Offers a 2.3% dividend yield?
• Is less risky than the overall market, with a beta of 0.75?
Hmmm…maybe you say, buy?
Before you say that though, I’m going to provide some more details about Elbit Systems (NASDAQ: ESLT). The company is in the defense industry, which scares many investors away because of the prospect of budget cuts. The sequester falls heavily on the Pentagon budget. And who knows, maybe world peace will break out soon?
In addition, Elbit Systems is one of the largest manufacturers of Unmanned Aerial Vehicles, or drones.
All of these factors make these shares controversial or give investors pause.
But they shouldn’t. If you recall, last August US citizens stood with many countries and said, “No boots on the ground in Syria.” No boots on the ground means, among other things, drones in the air.
In addition, there has been much more favorable publicity about drones in recent weeks. Pakistan, who always suggested that US drone attacks in their Northwest Frontier Provinces had unnecessary collateral damage, recently revised these estimates sharply downward so that they nearly agree with CIA statistics that have been compiled in recent years. Pakistan is also pleased that a recent drone strike took out Taliban leader Hakimullah Mehsud.
All this has bearing on the company’s financial outlook, which has brightened considerably in the last few quarters. Results were hurt in 2010 by a decline in margins due to R&D and other expenses. Now under control, gross profit percentages are back to the high twenties; operating margins are in the mid-teens; net profit margins have returned to high single digits. All these numbers resemble figures from the last decade—when the trailing PE was much higher!
Even before the spate of favorable publicity I alluded to above, Value Line was projecting 9% annual revenue growth in the near future. I suggest this will prove conservative. Third quarter EPS of $1.32 handily beat Value Line’s $1.20 guestimate; revenues of 730 million came in ahead of the $710 projections.
Given the better performance, I think the shares can command the 18x-20x multiple they sold for back in the previous decade. Applying an 18x multiple to Value Line’s 2013 estimate of $4.60 gives you an end of year price of nearly $83 dollars a share, nearly 50% higher than current levels. Price estimates based upon historical cash flow are a bit lower, but the shares still appear deeply undervalued at the moment.
While you wait, you can collect a well covered 2.3% dividend. Elbit has paid dividends since 2000, and over this span the payout has grown at better than a 10% annual clip. While the company has trimmed dividends in lean years, the cuts have been small and restored quickly when profits fall back into the groove.
For more information, visit www.elbitsystems.com
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