Subject: ITT Exelis (XLS) Final Thoughts
After thinking about it on and off over the weekend, I decided to sell the small position I had taken last week in XLS. The two key assumptions backing my decision are the following:
1. Management stated in the form 10 that "Overall operating margin has declined year over year due to a shift in sales from higher margin products to lower margin services, which is in line with our longer term expectation for the business."
2. The CEO stated in a Seeking Alpha post that defense spending was likely to be cut by hundreds of billions of dollars over the coming years.
Regarding point one, it would be foolish not to take management at their word on this, otherwise why would they include it in the form 10, knowing the implications for such a statement. A post on the blog Long Term Value posited that the issue of whether further margin compression would occur or not was a key factor to consider. In light of no other information I think you have to accept management’s assertion that margins can be expected to contract further in the future. Given that services margins are about half of product margins, this seems very negative from my perspective.
The implications on the second point are that the only way the company can increase the bottom line is either by cutting costs, taking market share or both. There is some evidence that the company is already implementing cut cutting actions. As to whether the company can take market share or not, who knows? However, with competitors like Lockheed Martin and General Dynamics, to me this is akin to trying to take lunch money from the school ground bully.
Also, the last reliable financial statements are nearly six months old, those being the 6/30/11 pro forma financials in the form 10. I consider the financials included in 9/30 10Q all but useless since they do not include the pension transfer, the pension re-measurement nor any of the other adjustments resulting from the spinoff.
Finally, I’m not sure the implications of the pension re-measurement are fully understood yet, assuming I’ve understood the issue correctly. If I had uncovered a positive that was not yet explicitly disclosed in recent financials then I would consider that a major reason to load up further on the stock. If on the other hand I’ve figured out a negative that is potentially not yet fully understood or has not yet been explicitly reported by the company then by the same logic I need to weigh that information heavily in deciding whether or not to sell.
This is admittedly a highly qualitative analysis but that’s where I’m at.
BTW, this morning the bid dropped by 10 cents by the time I had finished selling my 1,461 shares. And I sold when the market was up. Every time I placed my order a few hundred shares would sell and then the bid would drop a penny. On my last order the bid dropped 3 or 4 cents. When I was done selling it popped back from 8.78 to 8.84. HFT abuse? |
