Raytheon Board: Our Stock Is a Buy

Are Raytheon (NYSE: RTN) shares, which are trading near an all-time high, a good buy? The company's board seems to think so.

After markets closed on Wednesday, Raytheon declared a $0.7975 per-share dividend -- unchanged from the previous quarter -- and said its board had authorized the company to repurchase up to $2 billion in shares. That's on top of the $900 million available under Raytheon's previous repurchase program, which was authorized in 2015.

The new buyback continues a trend. Raytheon, in the last decade, has reduced its share count by nearly 30% via share repurchases, and management has said it expects to return about 80% of free cash to shareholders. But should investors get excited about this latest move?

Missile launch
Missile launch

A Raytheon-made Stinger missile is fired during a live fire exercise off the coast of Crete, Greece. Image Source: US Army, via Flickr.

A confident buyer

It's important to note that the board's action, as typical with repurchase decisions, is purely an authorization to buy at the company's discretion, depending on market conditions. This is good, because Raytheon shares are significantly more expensive now than they were just a few years ago. The company's stock is up about 30% year to date and up 76% in the past three years, and its trailing-12-month price-to-earnings and price-to-sales ratios are both at highs unseen for more than a decade.

Of course, Raytheon's outlook is a lot rosier than it was only a few years ago. The Pentagon, which saw its budget frozen earlier in the decade as part of partisan disputes in Washington, is expected to see a substantial funding uptick next year, thanks to GOP control of both Congress and the White House, and because of saber-rattling by North Korea, among others.

Raytheon is particularly well-suited to benefit from any spending increase, thanks to its focus on advanced armaments, missile defense, and sensors and surveillance gear.

Investors can also interpret the new repurchase authorization as a sign that the company expects to generate strong free cash flow in the quarters to come. That's not a given, considering Raytheon reported a quarter where it consumed more than $100 million in cash less than a year ago. Given how far shares have risen and the slow-cycle nature of the defense business, perhaps an additional buyback is the best chance for continued near-term appreciation.

Other options to the back burner

Still, investors might feel a bit disappointed that Raytheon, to date, hasn't found other uses for its cash. Rival Northrop Grumman, for example, is levering up to acquire Orbital ATK for $7.8 billion, and there are dozens of mid-sized companies out there that could give Raytheon new technologies or capabilities that, in turn, could help it win future Pentagon business.

Northrop also declared a dividend on Wednesday. However, it's going to need a few years to pay down the debt it's taking on in the Orbital deal, so it's unlikely to aggressively buy its own shares for now.

Raytheon CEO Thomas K. Kennedy told investors earlier this year that "the focus definitely is on growth and expansion," but he said most of what they have looked at they deemed overpriced. If that changes, some of the cash could still go toward mergers and acquisitions (M&A), but for now, it appears the priority is returning money to shareholders.

The company is also prioritizing buybacks over rapidly increasing its dividend. One byproduct of the stock's impressive climb is a declining dividend yield: Raytheon's dividend represented about a 4% yield as recently as 2011, but today, it's just 1.66%, despite dividend hikes for 13 consecutive years.

Raytheon's last dividend hike was last March when the company raised its quarterly payout by 8.9% to the current $0.7975 cents per share. It's a safe guess the company plans to do another hike in March 2018 in keeping with its pattern in recent years, but with cash available, Raytheon could have decided to move that decision up instead of buying more shares.

Individual investors will differ on whether they would prefer an appreciation-driving buyback or a cash boost from a higher dividend, based on their specific needs, or whether shares are held in a taxable account. No matter where one stands, however, it should now be apparent that rapidly increasing the dividend to boost the yield is not the top management priority.

If Raytheon is buying, should you?

Raytheon, with its quality portfolio and strong international exposure, is a standout in the defense sector, and long-term investors should sleep easy with this defense titan in their portfolios. But even with the new buyback authorization, it's hard to make the case that the company's shares will repeat their 2017 heroics over the next year.

Raytheon's board gave the green light to repurchase shares based on market conditions. Investors would be wise to heed that advice, and wait for a potential dip before buying in.

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Lou Whiteman has no position in any of the stocks mentioned. The Motley Fool recommends Orbital ATK. The Motley Fool has a disclosure policy.