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Defense builder armors the new armed forces
After big gains, Armor Holdings' growth is slowing. But the stock remains undervalued, and even with talk of defense cutbacks, its products will be in demand.
By Robert Walberg
(This story was updated at 4:41 p.m. ET Feb. 10.)
The thousands of football fans who descended on Jacksonville, Fla., for last weekend's Super Bowl probably had little idea that they were also visiting the home of one of Wall Street's best performers in recent years. Shares of Armor Holdings (AH, news, msgs), which makes products for the military, law enforcement and personnel safety markets, has risen by more than 55% over the past 52 weeks, besting the Standard & Poor's 500 ($INX) by a whopping 46%. Now that's something to cheer about!
Of course, Armor isn't the only defense company to enjoy big gains since George W. Bush became president. The Bush administration's ramping up of defense spending over the last four years sparked the sector's biggest rally since the end of the Cold War. Media General's Major Diversified Aerospace/Defense index is up 70% since March 2003.
Armor, which provides armor for soldiers' bodies as well as vehicles, has been in the sweet spot of the defense buildup. Its products have been in hot demand, especially since the Sept. 11, 2001, terrorist attacks and the conflicts in Afghanistan and Iraq.
This growth continued in the fourth quarter. Thursday afternoon the company said it earned 74 cents a share, better than the consensus estimate of 71 cents. Sales reached $337.5 million, well above the consensus estimate of $269.6 million. A year earlier, the company posted a loss of 17 cents a share, including a loss from discontinued operations, on sales of $112 million.
The company now has beaten consensus estimates in each of the last five quarters, and competitor Ceradyne (CRDN, news, msgs) just posted much better-than-expected results.
More importantly, with the recent increase in demand for vehicle armor stemming from solider complaints from Iraq that the government wasn't doing enough to provide it, Armor should be able to paint an optimistic view of 2005. Just a couple months ago, the Army requested that the company increase production of fully armored Humvees to 550 per month from 450 per month.
Pulling in business
Armor also recently landed a new $32.4 million order from Stewart & Stevenson Services (SVC, news, msgs) to provide armor components for the Family of Medium Tactical Vehicles (FMTV). This is on top of the $53.5 million contract the company won in early January from the Army's Tank-automotive and Armaments Command to provide add-on truck armor kits. Basically in the last month alone, the company has received new orders totaling roughly 9% of estimated 2004 revenues.
To management's credit, it isn't sitting on its hands during the boom period. Armor has used some of the more than $200 million in cash it had at the end of the third quarter to buy a couple of small security-related companies. Over the past few months, the company has completed a $92 million all-cash acquisition of The Specialty Group and a $60 million cash deal for Bianchi International. The former is a leading manufacturer of modular lightweight load-carrying equipment (MOLLE), outer tactical vests (OTVS) and Warrior helmets for the Army. Bianchi International is a leading supplier of holsters, belts and outdoor backpacks and daypacks.
In addition to diversifying its product offerings, especially in the fast-growing protective body-wear arena, the acquisitions should boost earnings. Armor's success in integrating these acquisitions, as well as others, is crucial in cementing its positioning as a leading long-term player in the evolving defense/homeland security sector. Acquisitions will also be pivotal so Armor can replicate the top- and bottom-line growth it has achieved in recent years.
From an investment standpoint, future growth is the big concern. While the Bush administration has overseen the biggest defense buildup in decades, there's growing unease on Wall Street that mounting deficits and sluggish economic growth will result in future cutbacks. The good news for Armor is that any cutbacks are likely to come from other areas of defense, especially if Defense Secretary Donald Rumsfeld is successful in implementing his vision of a less costly -- but more strategic and sophisticated -- fighting force that responds swiftly and surgically to developing threats as they develop around the globe.
More sustainable growth rates
Though such a plan will be more troublesome for the large-cap defense companies like Northrop Grumman (NOC, news, msgs) and Lockheed Martin (LMT, news, msgs) than for Armor, it's difficult to imagine Armor's prospects would continue to be strong in the face of general industry cutbacks. And, while 2005 sales and earnings are seen growing by 25% and 22% respectively, that's a far cry from the triple-digit growth posted in 2004. Basically, investors must begin adjusting to slower, more sustainable growth rates.
As they do so, investors are unlikely to assign the stock (or the sector) the type of premium multiples they've enjoyed over the past few years. Nevertheless, if Armor merely hits its projected earnings of $2.98 for 2005, the shares are still undervalued at today's price. The stock isn't likely to double or even post another 50% gain, but, with sales and earnings growing at more than 20% a year, a forward multiple of at least 18 times earnings seems reasonable.
A multiple of 18 would represent a slight premium to the group. But Armor's strong balance sheet, relatively high-profit margins and superior returns on equity and capital suggest that the premium is warranted. With this price-to-earnings ratio, the stock has the potential over the next six to 12 months to reach the $53-to- $54 area. (Major support for the stock is at $40.)
But with long-term growth expected to slow to the 12%-to-15% range over the next five years, investors should expect Armor's multiple to continue to contract. That doesn't make Armor a bad investment; it just means that the easy money in this stock -- and this group -- has been made already. From here on, value and selectively will be much more critical concerns for investors.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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