Streetwise for Sunday April 19, 2009

Streetwise

Lauren Rudd

Sunday, April 19, 2009

Kudos To Alan Blinder

After the so called “tea parties” of April 15, I can only say that kudos should go to economics professor Alan Blinder for his succinct portrayal of the government’s economic recovery plan. As Blinder put it, we are fighting a war on two fronts. On one front the battle is over a lack of demand. While we are winning after firing salvos of lower interest rates, tax cuts and the stimulus package recently enacted by Congress, victory is almost within grasp.

On the other front, the battle is over credit or more precisely the lack of it. Success here is more elusive. To win requires a restoration of health within the banking sector and a resumption of the issuance of credit. Although the Fed has flooded the banking system with loans, the overriding problem is a lack of capital. Moreover, the private sector is not yet stepping up to the plate, although there is some evidence of players warming up in the bullpen.

However, banks are only part of the problem. As Blinder points out, there is a shadow banking system, “A complex web of interlocking, and sometimes mysterious capital markets.” These shadow markets play a crucial role in ensuring the flow of credit.

The administration is trying to bring these shadow markets back to life through the implementation of various foreclosure mitigation programs and public-private investment partnerships. The Fed has also implemented an unprecedented agenda of lending and money-creation activities.

The bottom line is that taxpayer money is being put at risk for the simple reason that winning on both fronts is mandatory. Nonetheless, as in any war there will always be collateral damage. For now, it amounts to huge deficits, a record expansion of the money supply, and aid being offered to some for whom punishment is more befitting. And yes, some profiteering will take place. Dealing with those issues must be left to later. For now we need to concentrate on winning the war and righting our economic ship.

So how do you achieve above average investment returns given the current economic turbulence? One answer is to invest in companies that have a symbiotic relationship with the affairs of state, preferably on a global basis. A good example is Raytheon (RTN) and the global fight against pirates.

Raytheon's Silent Guardian Active Denial System (ADS) uses millimeter wave technology to excite water molecules in the surface layers of the skin, thereby creating a burning sensation. The weapon is non-lethal because its radiation does not penetrate deeply enough to cause lasting injury.

Weighing in at more than three tons with an antenna nearly four feet square, it would fit quite nicely on a ship. In addition to being non-lethal, ADS has the range necessary to keep bad guys at a safe distance.

Raytheon and the Navy are already exploring the possibility of using ADS to foil pirates. If the pirate threat continues to escalate, and it likely will, this could become a profitable line of business for Raytheon.

So how does Raytheon stack up as a possible investment candidate? When I wrote about the company a year ago, my 2008 earnings estimate was $3.92 per share. Earnings came in at $3.95 per share. There is more good news. The company recently announced an 11 percent increase in its annual dividend to $1.24 from $1.12.

The intrinsic value of the shares, using a discounted earnings model with a 10 percent discount rate and an earnings growth rate of 11 percent, is $102 per share. The more conservative free cash flow to the firm model yields an intrinsic value of $134 per share. Raytheon’s shares recently closed at $42.21 and have chalked up a 24.81 percent gain so far this year.