Why Raytheon Could Deliver Improving Returns

A sound strategy may boost its financial prospects

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Raytheon Co.'s (RTN, Financial) investment in existing products could catalze its stock performance. The company is seeking to improve its competitive advantage through disrupting its own technology.

The Massachusetts-based defense contractor is also seeking to further internationalize its business as it aims to capitalize on improving growth prospects for the global defense sector. Cybersecurity could be a key growth area, with the company gradually building its presence in the segment.

Although changes to government reimbursement payments could cause uncertainty for the business, the growth potential in the space segment may help to offset it. Having fallen 19% in the last year versus a 7% decline for the S&P 500, the stock could have recovery potential.

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Investment

The company’s investment in improving its own products could boost its financial prospects. It is seeking to disrupt its own technology in order to keep its franchises relevant to existing and new customers. It has received positive feedback on its Lynx Infantry Fighting Vehicle, which will meet the U.S. Army’s requirements for a next-generation combat vehicle. It is also set to deliver a new propulsion system for its TOW missile system. It will increase the weapon’s range, while enhancing protection for ground troops.

Raytheon is also updating its Stinger surface-to-air missile. The missile has been in use for around 40 years, with it being deployed in more than 18 nations and by all four of the U.S. military services. Its latest update enables a lightweight self-contained air defense system to destroy a wider range of battlefield threats, including unmanned aircraft systems. Improvements to the Excalibur precision guided projectile are set to enable soldiers to eliminate targets in challenging locations. Additional updates to its successful franchises could lead to an improved competitive position.

International growth

Global defense spending is forecasted to grow 3.2% per annum over the next four years. Raytheon is expanding its international presence and is aiming to increase the portion of total sales generated in international markets from its 2017 level of 35%. It is seeking to develop international sales opportunities for its Patriot missile defense franchise, with Sweden recently becoming the 16th country to use the system. Poland and Romania are also expected to place additional orders over the next several years.

The company continues to invest in its cybersecurity segment. It was recently awarded a multiyear contract with a new customer in the Middle East and North Africa region to provide cybersecurity solutions and operational support. The company is building a significant cybersecurity portfolio through continued investments in an industry that is projected to grow 10.2% annually over the next five years.

Risks

Raytheon’s financial performance could be negatively affected by a potential change in how defense contractors are paid by the U.S. government. Under existing arrangements, defense companies are liable for the cost of all projects, with the government reimbursing them at specific points. Those reimbursements could be reduced, which would leave defense companies requiring stronger cash flow in order to fund a greater portion of projects. This could mean they require stronger balance sheets or more leverage, which could hurt their cash flow.

Updates to the rules are not expected to impact existing contracts, with any potential change unlikely to be effective until 2020 at the earliest. Defense spending also remains a key focus of the Trump administration, with demand for a variety of equipment likely to remain robust as geopolitical risks involving China and Russia remain high. Raytheon also sees the space segment as a growth catalyst. It supplies a large portion of the sensors and electronics used in highly classified satellites. The defense budget for space programs is set to increase rapidly from $7.8 billion in 2018, which could catalyze the company’s financial performance.

Outlook

An increasingly international focus could improve Raytheon’s financial prospects. The company is aiming to capitalize on growing international demand for its products, with geopolitical risks expected to remain high. It is investing in updating and disrupting its own products, which could improve customer demand and boost its competitive advantage. It is also aiming to increase its exposure to the growing cybersecurity market.

Although changes to government reimbursement protocol are a potential threat to its financial outlook, the company has growth potential within the space segment. Having underperformed the S&P 500 over the last year, the stock could have investment appeal.

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