Why Is Harris (HRS) Down 14.2% Since Last Earnings Report?

It has been about a month since the last earnings report for Harris (HRS). Shares have lost about 14.2% in that time frame, underperforming the S&P 500.

Will the recent negative trend continue leading up to its next earnings release, or is Harris due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important drivers.

Harris Q1 Earnings Beat on Higher Sales, FY 19 View Up

Harris delivered solid first-quarter fiscal 2019 results, wherein both the top line and the bottom line surpassed the respective Zacks Consensus Estimate.

Net Income

On a GAAP basis, net income for the reported quarter increased 34% year over year to $213 million primarily due to top-line growth and tax benefit.

Earnings from continuing operations increased to $1.78 per share from $1.36 per share in the year-ago quarter, beating the Zacks Consensus Estimate of $1.70.

Revenues

Quarterly revenues increased 9.4% year over year to $1,542 million, driven by growth across all three segments particularly Communication Systems and Electronic Systems. The top line exceeded the Zacks Consensus Estimate of $1,528 million.

Segmental Performance

Revenues from Communication Systems segment came in at $469 million for the reported quarter, up 16% year over year, due to double-digit growth in all three businesses — Tactical Communications, Public Safety and Night Vision. Operating income grew 22% year over year to $140 million owing to increased volume and operational efficiencies.

Revenues from Electronic Systems unit were $589 million, up 9% year over year. This is attributable to growth in Avionics on increased F-35 production, Electronic Warfare from F/A-18 and CV-22 platforms, ramping of the U.K. robotics program and growth in missile defense programs in C4ISR. Operating income for the segment was $115 million, up 6% year over year.

Revenues from Space and Intelligence Systems unit increased 5% year over year to $488 million, owing to growth in classified programs, driven by small satellites and exquisite systems. Operating income decreased 1% year over year to $86 million as higher volume was offset by increased investments in innovation.

Merger Deal

In a separate announcement just before releasing first-quarter results, Harris declared that it has inked a deal to merge with L3 Technologies, Inc. (LLL) in an all stock merger of equals transaction, in a bid to create a global defense technology leader. The deal is anticipated to close in mid-calendar year 2019, subject to customary closing conditions.

Notably, L3 Technologies is a leading provider of global intelligence, surveillance and reconnaissance, communications and electronic systems for military, homeland security and commercial aviation customers. Per the agreement, L3 shareholders will receive a fixed exchange ratio of 1.30 shares of Harris common stock for each share of L3, consistent with the 60-trading day average exchange ratio of the two companies. After completion of the deal, Harris and L3 shareholders will own approximately 54% and 46%, respectively, of the combined company — L3 Harris Technologies, Inc.

Reportedly, the combined entity will be the sixth largest defense company in the United States and a top 10 defense company globally, with approximately 48,000 employees and customers in more than 100 countries. The deal will enable Harris to increase scale, strengthen core businesses and fortify position as a premier global defense technology company. For calendar year 2018, the combined company is expected to generate net revenues of approximately $16 billion, EBIT of $2.4 billion and free cash flow of $1.9 billion.

Cash Flow and Balance Sheet

Harris generated $117 million of cash from operating activities in first-quarter fiscal 2019 compared with $95 million in the year-ago period. During the reported quarter, the company generated free cash flow of $86 million compared with $72 million in the previous-year period. At the end of first-quarter fiscal 2019, the company had $305 million of cash and cash equivalents with net long-term debt of $3,410 million.

Harris increased dividend by 20% and returned $282 million to shareholders through dividends and share repurchases in first-quarter fiscal 2019.

FY19 Guidance Up

Owing to solid first-quarter performance, Harris raised guidance for fiscal 2019. The company expects revenues in the range of $6.53-$6.65 billion, up 6-8% from fiscal 2018. Earnings per share from continuing operations are anticipated between $7.80 and $7.90, up from the previous guidance range of $7.65 and $7.85. While free cash flow is projected to be around $1 billion, tax rate is assumed to be in the vicinity of 16.5%, down from the previous guidance of 17%.

Moving Forward

Harris’ superlative performance despite high volatility in the equity markets is a testament of its strong fundamentals and healthy growth dynamics due to higher demand for security products amid geopolitical tensions. The merger deal with L3 will further augment its market position and lead to industry consolidation, offering it economies of scale. The long-term growth prospects of the company, therefore, appear quite enterprising.

How Have Estimates Been Moving Since Then?

In the past month, investors have witnessed an upward trend in fresh estimates.

VGM Scores

Currently, Harris has a subpar Growth Score of D, though it is lagging a bit on the Momentum Score front with an F. However, the stock was allocated a grade of C on the value side, putting it in the middle 20% for this investment strategy.

Overall, the stock has an aggregate VGM Score of D. If you aren't focused on one strategy, this score is the one you should be interested in.

Outlook

Estimates have been trending upward for the stock, and the magnitude of these revisions looks promising. It comes with little surprise Harris has a Zacks Rank #2 (Buy). We expect an above average return from the stock in the next few months.

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