Thursday, January 20, 2011

L-3 Communications offers long term value with a margin of safety

I believe $LLL, at approximately $78/share, offers long term value with a margin of safety on a cash flow valuation basis.

L-3 Communications is a leading provider of high-technology products, systems, and subsystems in the defense electronics business. The company sells products to the U.S. Department of Defense (76% of 2009 sales) as well as other U.S. and foreign governmental agencies and commercial customers. Areas of focus include intelligence, aircraft modernization, simulation and training, communication systems, and specialized products such as bomb-detection equipment.
I estimated the firm's WACC at 9.30% using the Capital Asset Pricing Model and the company's recent SEC filings.  ValuePro has a baseline WACC calculator here and it calculates the firm's WACC at 6.74%.  I'm going with the higher mark, 9.30%.

Recent free cash flows and noted growth rates:
YearFCF $Millions
Average Annual Growth: approx 38%
CAGR: approx. 35%
Internal Growth Rate: approx. 5%
Sustainable Growth Rate: approx. 13%
Consensus Forecast Industry 5-Year Growth: approx. 17% per year
Consensus Forecast Company 5-Year Growth: approx. 8% per year
Assuming the company achieves a lower 5-year growth rate of 3% per year, and assuming that after the next five years, the company achieves no growth or 0% growth per year forever.
Discounted Cash Flow Valuation:
YearFCF $ Millions
Terminal Value16131
The firm's future cash flows, discounted at a WACC of 9.30%, give a present value for the entire firm (Debt + Equity) of $15,616 million. If the firm's fair value of debt is estimated at $4,307 million, then the fair value of the firm's equity could be $11,309 million.
$11,309 million / 113 million outstanding shares = $99.91 per share. A 20% margin of safety from here is approx $80 per share and $LLL's current share price is approx $78.  I believe $LLL currently offers long term value with a margin of safety on a cash flow valuation basis.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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