Speak Softly and Own These Defense Stocks: Market Recon

 | Apr 12, 2018 | 7:55 AM EDT
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"Speak softly and carry a big stick"

-- President Theodore Roosevelt

I really don't know. I do know that every U.S. president, at least in the modern era, is forced to carry a big stick. It's part of the job, and frankly, I would think that when one applies for said job, one understands the gravity associated with such responsibility. Teddy Roosevelt has always been one of my favorite presidents. He was, to but it bluntly, something of a tough guy, overcoming childhood illness, and ascending to the presidency at a very young age (42) due to the assassination of President William McKinley in September 1901. It was during his term, and his enforcement of the Monroe Doctrine that the United States really became a regional power.

More than a century later, the "stick" that U.S. presidents carry is much, much bigger. Global communication has improved to the point where one at that level can make his or her impact felt almost immediately. In theory, that should reduce room for error. In practice, I'm not so sure. Meant to intimidate? OK, I could see purpose there. If impulsive, however, it does not help to publicly outline a military action ahead of such action being implemented. Scuttlebutt is that in response to recent tweets, Syria has moved fighter jets to safer (perhaps Russian) locations, and that various units have taken up more defensive positions in preparation for an "imminent" U.S. strike against the nation in retaliation for the Syrian government's alleged use of chemical weapons.

On top of that, this forces U.S. assets in the region to also proceed with a posture that is more defensive in nature -- all while Secretary of Defense James Mattis says that the U.S. is still assessing the intelligence that the Assad regime is truly behind this attack. Now, again, if this is simply public intimidation meant to force bad guys to scramble, then I would see "tweets" such as what we saw Wednesday as shrewd rather than impulsive. Either way, the world remains dangerous, and dangerous toys are not just simply in demand, but demand is increasing rapidly both home and abroad.

Winning Championships

Lockheed Martin (LMT) : As I wrote yesterday, Lockheed' s older F-16 jet is considered a front runner in the Indian Air Force's potential $15 billion order for 110 fighter aircraft. Lockheed also produces the more modern (and stealth capable) F-22, and F-35 fighters. Both of these fighters are professionally thought to be effective against Russia's S-400 long range air defense missile system. That system is currently deployed in western Syria. Last week, LMT also won a $247 million contract from NASA to design and build an experimental aircraft that could operate without creating a traditional sonic boom. My price target: $375.

Raytheon (RTN) : First off, should the president decide to strike Syria without the use of American pilots, guess who produces the Tomahawk missile? That's right. These guys. On top of that, you might have noticed that two weeks ago, Poland agreed to spend $4.75 billion on RTN's Patriot missile defense system. By the way, this is the largest weapons deal in the history of Poland. Russia's annexation of the Crimean peninsula has not been lost on this former Warsaw Pact nation.

In addition to increasing the dividend, Action Alerts PLUS holding Raytheon announced in late March that under the Department of Defense's DARPA program, it was developing technology that could control swarms of both air-based, and ground-based drone vehicles that might be launched using a "drag and drop" visual interface. My price target: $245.

General Dynamics (GD) : This is one firm where we have already seen cash flows and margins improving. GD is also another defense name that increased their dividend in March. Think the Navy gets some love in the 2018 federal budget that earmarked $654 billion for the Pentagon? Me too. Know who runs the Virginia class submarine program? GD. In fact, the Navy just awarded a $696 million modification to that program for 2019.

One worry here is exposure to China. China is expected to be the hottest market for business jets over the next couple of decades, and GD's Gulfstream is the most popular business jet in that nation. Canada's Bombardier BDRBF is number two in that market, and eager. This will be a risk through the March 15 tariff hearing in Washington. My price target: $245

Kratos Defense & Security Solutions (KTOS) : The stock has performed spectacularly since being impacted by the negative press regarding the Spruce Point analysis in mid-March. This calendar year, KTOS has landed at least $187.7 million in a series of awarded contracts, the details of which are at times murky due to the nature of the business. Though Spruce Point was correct in its assertion that the firm has gone through "multiple reinventions now hyping drones," it is just that, the elite level unmanned drone business, that is poised only to grow at this point, in my opinion.

Total debt is down significantly from fourth quarter 2016. Cash and equivalents have grown more than 85% over that time. Both the Current and Quick ratios are above 2.0, meaning Kratos is able to meet obligations, all while EBITDA and operating margins have grown significantly. P.S. The retail crowd can afford to play this name. My price target: $14.

Drill Down

I am personally long the four names above. There are many attractive names in the group. I just don't have room for seven of eight names without over-exposing myself to the space. No Boeing (BA) , you ask? That's one that got away from me in 2017, and another name suffering from exposure to a potential trade war with China. There is risk around this one, at least through that May 15 date.

Other interesting names that the individual investor may wish to explore could be Harris Corp. (HRS) , Northrop Grumman (NOC) , United Technologies (UTX) , L3 Technologies (LLL) , Flir Systems (FLIR) , and TransDigm Group (TDG) .

A bit much for you? The are ETFs that cover the space. Among others, you could take a look at iShares U.S. Aerospace and Defense ETF (ITA) , and SPDR S&P Aerospace and Defense ETF (XAR) . Just be forewarned that XAR carries a slightly lower expense ratio, and seems to spread the wealth a little more evenly. The fund's top-10 holdings all weigh between 3.6% and 3.3% on the portfolio. As for ITA, Boeing makes up 10.4% of the fund's holdings all by itself.

Economics (All Times Eastern)

08:30 - Export Prices (March): Expecting 0.2% m/m, Last 0.2% m/m.

08:30 - Import Prices (March): Expecting 0.2% m/m, Last 0.4% m/m.

08:30 - Initial Jobless Claims (Weekly): Expecting 230K, Last 242K.

10:30 - Natural Gas Inventories (Weekly): Expecting -65B cf, Last -29B cf.

13:00 - 30 Year Bond Auction: $13B.

17:00 - Fed Speaker: Minneapolis Fed Pres. Neel Kaskari.

Today's Earnings Highlights (Consensus EPS Expectations)

Before the Open: (APOG) (.76), (OZRK) (.85), (BLK) (6.41), (CBSH) (.79), (DAL) (.73), (RAD) (-.02)

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