Future U.S. defense spending cuts are increasingly likely. And aerospace and defense contractors are already feeling the chilling effects. L-3 Communications Holdings (LLL) is in that group.

The company makes command, control, surveillance, and other products that are impacted by government budget shrinkage. And 87 percent of L-3’s fiscal 2010 sales were generated by U.S. government and commercial clients.

Not surprisingly, L-3’s sales were recently stuck in reverse. First-quarter net sales sank 1 percent to $3.601 billion versus $3.624 billion a year earlier. Operating income decreased 5 percent. Sales grew in segments like surveillance, but aircraft modernization and electronic systems both posted sales decreases.

Shareholders, however, are uppermost in L-3’s priorities. The stock currently yields 2.2 percent and its dividend per share has grown 24 percent over the past five years, beating competitors such as Northrop Grumman (NOC). Also, the dividend looks secure, given L-3’s strong free cash flow and a conservative pay-out ratio.

Government dependent

For now, analysts deem L-3 worth holding. Of the 19 analysts listed tracked by Thompson/First Call, only one has a buy recommendation, with 15 holds, three underperforms and one sell.

Zacks Investment Research recently affirmed its neutral rating for L-3, citing loss of key contracts, large number of fixed-price contracts that cap costs, and possible defense budget cuts.