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Tickers in this Article: COL, LLL, DRS
In High Fliers we took a look at airborne weapons delivery platforms such the F-18 Hornet, the F-15 Eagle, the Navy's F-14 Tomcat and the new joint strike fighter, the F-22 Raptor. No matter how terrific an aircraft is, it has to have the guidance avionics to know where it's going, the operational communications for command and control, and the ability to see its target in daylight, at night and in kind of weather.

We are going to take a look at three of the defense contractors that supply this technology. The more accurate weapons systems are, the fewer friendly fire incidents you have and the less collateral damage you cause. (For a larger perspective, check out War's Influence On Wall Street.)

GPS (Global Positioning System) and then some
Rockwell Collins
(NYSE: COL) was formed in 2001 when Rockwell was split into two companies. COL has two basic business units, the commercial segment and the government segment.

They derive 46% and 54% of their revenue from those business units respectively. As good as commercial avionics are, military grade equipment is that much better. It is so accurate that it defies description.

Rockwell Collins has one of the highest returns possible under current contract policies from the Defense Department and has posted substantial gross margins as a result, hovering on either side of 20%. With less than 10% of their balance sheet in debt and plenty of free cash flow, they are free to continue to pursue key acquisitions. COL continues to repurchase their shares back; 30 million in the last five years with more in their budget.

To date, COL has done an incredible job, at one point returning five times what the S&P 500 or DJIA has over the last four or five years. The risk in owning COL is: can they continue to execute defense programs on time and on economic target? Will any future acquisitions provide the same or better contributions as past ones have and can they maintain or expand their margins? So far, as market performance goes, there is no sign of a top.

We copy 5 by 5
L-3 Communications
(NYSE: LLL) manufactures secure and specialized communications equipment for satellite, avionics and marine applications with three-quarters of their business coming from the U.S. government. Those three applications or environments cover a lot of territory, some of which are extremely high priority systems.

L-3 provides high-value products that fit into the Defense Department's network-centric warfare and mission-critical technology plan with secure data links, sensors that integrate with other applications, cryptology capable and all via satellite command and control. Much of L-3's growth to date has been through acquisitions and has no qualms about making more. Future merger and acquisition activity will probably be the type of firms that will easily add value or integration to current product lines.

One of the problem areas that L-3 faces, besides having to deal with a fickle government, is paying too much for companies that it acquires. We are at the top of a cycle in that regard. L-3 is also dealing with an option back-dating scandal and is embroiled in several lawsuits. Lastly, L-3's share repurchases last year amounted to 1.8 million shares.


We Can See You

DRS Technologies (NYSE: DRS) derives basically all of its revenue ($2.6 billion in 2006) from the U.S. government. The company primarily manufactures electronic systems that can monitor military movements and thermal imaging systems that can see a target under any type of weather condition. DRS also manufactures combat workstations and electronic sensor systems.

The fact that the company's revenue is almost exclusively from the government makes DRS a riskier investment choice, as defense spending could lowered in the near future. Furthermore, although their margins are thiner when compared to other defense contractors, their growth in revenue and earnings has been admirable.

On Target
Keep in mind that the manufacturer of certain key weapons systems is considered classified information for the interests of national security. What isn't classified is the knowledge that the use and demand for this type of technology is currently increasing at an exponential rate. Perhaps these three companies will help put your portfolio back on target.

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