came about from the merger of equals between L-3 Technologies, a sensor-maker that operated a decentralized business focused on inorganic growth, and the Harris Corporation, a sensor and radio manufacturer that ran a more unified business. Underpinning the merger’s thesis was an assumption that additional scale would primarily generate cost synergies but that eventually, the firms would produce meaningful revenue synergies.

Cost synergies to a large extent drove the 30-year wave of consolidation across the defense industry, which has largely generated shareholder value. Arguably, L-3 was an ideal partner for a merger of equals because L-3 operated as a holding company and there are quite a few potential efficiencies from consolidating the firm into a more integrated firm. The three biggest firm-specific growth opportunities for L3Harris Technologies are the tactical radios replacement cycle, national security satellite asset decentralization, and electronic warfare capabilities.

Supply-Chain Issues Constrained L3Harris Q3 Sales, But booking remains same 

L3Harris reported a strong third quarter as sales were limited by supply chain issues. That noted, the shorter-cycle prime is showing its portfolio is well aligned in the decelerating funding environment, as the organic backlog of about $21 billion is up 9% from last year and 4% year to date. Many peer defense contractors have had declining backlogs in 2021. Revenue of $4.2 billion missed FactSet consensus by 6.6% but non-GAAP EPS of $3.21 beat FactSet consensus by 0.8%. Organic revenue declined 1.2% as a 5.2% organic revenue decline in communications systems due to supply chain difficulties and a 2.6% revenue decline in integrated mission systems due to the timing of contracts more than offset low single- digit growth in the firm’s other segments. Sales activity was strong, the firm posted book/bills above 1 in three of the firm’s four segments, indicating that the firm’s revenue pipeline remains robust.

Financial Strength

L3Harris is in solid financial shape. The firm increased debt by about $4.5 billion in 2015 to fund the acquisition of Exelis, a sensor-maker that was spun off from ITT and had been paying down debt since. The firm’s all-stock merger of equals with L-3 Technologies did not dramatically increase debt relative to size, and projecting a 2021 gross debt/EBITDA of roughly 2.1 times, which is quite manageable for a steady defense firm. 

While L3Harris has some exposure to commercial aviation (depending on definitions, roughly 5% -15% of sales), The firm will be materially affected by the downturn in commercial aviation. L3Harris produces a substantial amount of free cash flow and is not especially indebted, so we anticipate that the company would be able to access the capital markets at minimal cost if necessary. 

Bulls Say’s

• There is substantial potential for cost synergies from the merger with L-3 due to the decentralized organizational structure of the pre-merger entity.
• L3Harris is at the base of a global replacement cycle for tactical radios, which we think will drive substantial growth.
• Defense prime contractors operate in an a cyclical business, which could offer some protection as the U. S. is currently in a recession.

Company Profile 

L3Harris Technologies was created in 2019 from the merger of L3 Technologies and Harris, two defense contractors that provide products for the command, control, communications, computers, intelligence, surveillance, and reconnaissance (C4ISR) market. The firm also has smaller operations serving the civil government, particularly the Federal Aviation Administration’s communication infrastructure, and produces various avionics for defense and commercial aviation.

(Source: Morningstar)

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Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.