Morningstar | Raytheon Continues to Generate Excess Returns and Growth Despite an Underperforming Cyber Business
Raytheon is one of five major U.S. defense contractors left standing after a wave of mergers during the 1990s consolidated the industry. The company operates five segments: integrated defense systems; missile systems; space and airborne systems; intelligence, information, and services; and Forcepoint. IDS specializes in radars and missile defense; MS produces munitions and missiles; and IIS focuses on services, offering training, engineering, and logistics. The Forcepoint business focuses on cybersecurity for government and commercial customers. Raytheon's returns lagged its cost of capital in the early 2000s due to a hangover from a spate of mergers and acquisitions in the late 1990s. However, management has refocused on operations and contained costs. Raytheon improved its segment operating margins to 12.4% in 2017 from 7% in 2004. Return on invested capital exceeded the cost of capital even as revenue fell to $22.8 billion in 2014 from $24.8 billion in 2011. The company now has the flexibility to invest in its business, fund pensions, and return capital to shareholders.Increased geopolitical instability has translated into international sales, which account for over 30% of revenue, and U.S. defense spending is set to increase under the Trump administration. Raytheon's Patriot system and its duopoly in missiles with Lockheed allow it to consistently win international and U.S. contracts. Its fledgling cybersecurity business, Forcepoint, accounts for less than 3% of sales, but Raytheon spent about $2 billion on M&A to build it. Forcepoint is in rebuilding mode after a poor 2017 performance.After shrinking from 2011 to 2014, Raytheon increased revenue at an accelerating pace from 2015 to 2017. We expect the company to continue growing from 2018 through 2022; we forecast 5% annual average revenue growth over this period combined with double-digit earnings per share growth in 2018, 2019, and 2020. We think the company's wide moat confers durable competitive advantages, which we expect to translate into returns above the cost of capital for years to come.Raytheon, together with its subsidiaries, is a technology company, focused on defense and other government markets. The company has five segments: Integrated Defense Systems, which is engaged in integrated air and missile defense; large land- and sea-based radar solutions; command, control, communications, computers, cyber and intelligence solutions; Intelligence, Information and Services, which provides technical services to intelligence, defense, federal and commercial customers; Missile Systems, which produces missile and combat systems; Space and Airborne Systems, which develops integrated sensor and communication systems for missions; and Forcepoint, which develops cybersecurity products.
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