While short-term worries may pressure defense stocks, several top experts believe long-term geopolitical trends continue to point to strong growth. Seven MoneyShow.com contributors assess the sector, highlighting diversified ETFs as well as top individual stock ideas among aerospace and naval contractors, drones, building security, biological threats and cybersecurity.
John Eade, Argus Research
The political drama continues to unfold in Washington, DC. But defense spending -- which has been a hot button in the past -- is now receiving bipartisan support. The Senate approved by a vote of 93-7 to spend $675 billion, up 3% year over year, on DOD programs such as Navy ships and submarines, F-35 aircraft and Black Hawk and Apache helicopters.
The budget backdrop for the Aerospace & Defense companies is certainly more positive than it was during the dark days of budget sequestration. Here are four Argus Buy-rated companies in the Aerospace & Defense sector that could benefit from a boost to defense spending:
Lockheed Martin Corp. (LMT)
Lockheed has consistently surprised the Street in recent years, regardless of whether defense spending is rising or falling. We have a favorable view of the company's focus on international revenue diversification (now 25% of sales), and expect increased geopolitical tension to benefit sales and earnings going forward.
The company is mindful of shareholder returns and has raised the dividend at a double-digit rate for the past 15 years while also aggressively buying back stock.
Northrop Grumman Corp. (NOC)
Northrop Grumman is a leading global defense contractor with a focus on aerospace and, increasingly, electronic programs including cybersecurity. The company's balance sheet is clean, and management has a history of meeting and beating analyst expectations. Management is also aggressively increasing the dividend, with two hikes in the past year.
Raytheon Co. (RTN)
We expect management's focus on its international and cybersecurity businesses to generate stronger growth over the next three to five years. RTN's business mix appears favorable compared to that of most defense industry peers.
And given rising geopolitical threats, we like its emphasis on advanced missile defense, electronic warfare and cybersecurity systems. The company is also generating strong cash flow and aggressively returning cash to shareholders through increased dividends and share buybacks.
General Dynamics Corp. (GD)
General Dynamics' diversified business mix is attractive compared to those of many peers, as a relatively low 60% of revenue comes from the U.S. government, thus reducing the company's exposure to the budget debates in Washington.
Management is focused on driving growth through modest sales increases, margin improvement, and share buybacks, and has a history of delivering positive EPS surprises. The company is also aggressively returning cash to shareholders through increased dividends.
Charles Mizrahi, Park Avenue Investment Club
Huntington Ingalls Industries (HII) is the largest military shipbuilder in the U.S. It builds ships in Mississippi and Virginia. And it's one of two companies that build nuclear submarines for the U.S. Navy. Most of its revenue comes from the Navy and Coast Guard.
Huntington Ingalls released its second-quarter earnings on Aug. 2, 2018. Management also gave its thoughts on the shipbuilding environment:
Capital Return: Huntington Ingalls' goal is to return almost all free cash flow to shareholders. It returned $279 million to shareholders in the quarter. That exceeded free cash flow of $154 million.
Solid Financial Results: The Newport News segment carried Huntington Ingalls' earnings. Companywide revenue grew by 9%. At Newport News, revenue was up by 18% and income was up by 14%.
Strong Shipbuilding Environment: Management called this the "most exciting time" in shipbuilding in 30 years. The company is currently bidding on contracts that will show up in its financials over the next five to 10 years. If the bidding process goes well, revenue growth should exceed the company's guide of 3% annually.
The stock was added to our Special Situations portfolio in 2012 at a price of $38.15 per share. Since then, profits have continued to grow and the stock price has marched higher. Huntington Ingalls is currently trading at over $200.
Our buy-and-hold approach with Huntington Ingalls has yielded splendid results. But I still see more upside from here. If you're underinvested or want to add to your position, I recommend buying Huntington Ingalls at a price no higher than $270 per share.
Tom Bishop, BI Research
Emergent Biosolutions (EBS) addresses accidental, intentional and naturally emerging public health threats to both civilian and military populations. It makes and commercializes medical counter measures to infectious diseases (like Ebola, Zika, and even smallpox) as well as CBRN threats -- Chemical, Biological (such as anthrax), Radiological and Nuclear.
Emergent is the #1 medical provider of vaccines and the leading provider of antibody therapeutics to the strategic national stockpile. It's good to know there are companies like this around.
In late August, Emergent announced the acquisition of Adapt Pharma (for $635 million) and its flagship product NARCAN, the only nasal spray used for the emergency treatment of opioid overdose. Few national health threats are currently more in the public eye. Emergent feels confident that with its skill set it can grow the business from there. (For example, only about 5% of high schools and colleges carry NARCAN.)
We're forecasting about 40%+ revenue growth next year, explaining the 34% increase in 2019 EPS estimates. Meanwhile Emergent is trading at a very reasonable froward P/E. We rate the stock a Buy.
Napco Security Technologies (NSSC) makes the widest variety of security products of any of its competitors. That includes electronic locking devices, doors with automated locks that can be wirelessly controlled to lock down a wing, a floor or an entire building - or even just the door(s) into a single classroom with a teacher's small electronic remote.
Such systems can also be found in hospitals, airports, military bases, apartment buildings; you name it. This company doesn't just make automated wirelessly controlled locks; it also makes a host of access devices to limit access to a given room, controlled by key pads, coded badges, etc. that allow access to only certain doors.
While management does not provide guidance, analysts expect EPS to rise 29% this fiscal year from $0.41 to $0.53 and 32% next year to $0.70. The stock has backed off a bit in recent trading; I think it is an excellent buy.
Tony Sagami, Weiss Ratings
Is bigger better? When it comes to the business of bombs and bullets, it sure seems so. L3 Technologies (LLL) and Harris Corp. (HRS) , agreed to a merger of equals that will create the sixth-largest defense contractor in the U.S. with annual sales of around $16 billion.
While both sell to the Pentagon, they aren't the traditional bombs-and-bullets types of military contractors. Instead, they provide the high-tech equipment that the new, modern military needs today.
The have been a number of defense industry mergers recently. In the last 18 months United Technologies (UTX) acquired Rockwell Collins for $30 billion; aircraft-parts maker TransDigm Group (TDG) bought Extant Components Group for $525 million; and Boeing (BA) bought aircraft components distributor KLX Inc.
Part of that stems from the fact that defense spending under Donald Trump is rising. Congress passed a $674 billion military budget last month, including the largest pay increase to service members in 10 years. That bigger budget will certainly translate into more business for the military industrial complex. But the most important change is the elimination of the cap on defense spending.
Under the Budget Control Act of 2011, U.S. military spending was capped at $550 billion a year. But President Trump signed the National Defense Authorization Act into law in last December, and now the floodgates for future military spending are essentially wide open.
That expectation of more and more military spending is behind this merger flurry and I expect defense stock prices to go higher and higher.
Large-caps defense stocks are worthy of your consideration. However, there are several small-cap defense contractors that look ripe for takeover and that also get solid Weiss Ratings. They include: Carpenter Technology (CRS) , Huntington Ingalls Industries (HII) and Curtiss-Wright (CW) .
If you're more of an ETF investor, take a look at the iShares U.S. Aerospace & Defense ETF (ITA) , SPDR S&P Aerospace & Defense ETF (XAR) and Invesco Aerospace & Defense ETF (PPA) .
Defense stocks have been on a roll ever since 9/11, and that terror attack redefined the priority that our country has placed on military strength. Neither Republicans nor Democrats can afford to appear anti-military.
That means more military spending for as far as the eye can see, and bigger profits for the defense food chain -- especially for the military technology segment.
John Reese, Validea
We select stocks based on the investing strategies of well-known, top-performing advisors; AeroVironment (AVAV) has been added to the portfolio based on the small-cap growth investor strategy of the Motley Fool.
The company operates through the Unmanned Aircraft Systems (UAS) segment, which focuses primarily on the design, development, production, support and operation of UAS and tactical missile systems that provide situational awareness, multi-band communications, force protection and other mission effects.
It supplies UAS, tactical missile systems and related services primarily to organizations within the U.S. Department of Defense.
The small-cap growth methodology developed by the Motley Fool seeks companies with a minimum trailing 12-month after tax profit margin of 7%. The companies that pass this criterion have strong positions within their respective industries and offer greater shareholder returns.
The company also passes the required tests for relative strength, positive cash flow, profit margins and cash. The stock's trailing 12-month debt/equity ratio of zero is at a great level according to this methodology because the superior companies that you are looking for don't need to borrow money in order to grow.
Briton Ryle, The Wealth Advisory
Leidos Holdings (LDOS) delivers technology solutions and services to the national security, health, and engineering markets in the U.S. and internationally. The company works with the Department of Defense as well as Homeland Security.
The company has beat estimates in each of the past four quarters. Leidos added two contracts worth $639 million in August. I expect we'll watch our shares move with the general market in the short term. But I'm looking for big moves up in the medium to long term here.
The world is pretty much bouncing from one conflict to the next. And as tensions continue to mount between the East and West, we'll see stronger demand for the kind of services Leidos Holdings provides.
I expect that 2019 will be a much busier year as far as contracts are concerned. Keep adding shares, especially on dips. The stock is a Buy anywhere under $75; our 12-month target is $105.
Jim Powell, Global Changes & Opportunities Report
Cybersecurity is an industry with exceptional potential for expansion. No computer or network today is safe from hackers. Cyber attacks have gone from stealing money, to stealing industrial and military secrets, and disrupting both civilian and military infrastructure.
Along the way, foreign agents have been tampering with the election results of countries throughout the world. The amount of damage being done by cyber attacks is so great that fighting it has become a multi-billion-dollar industry that should expand significantly for many years.
CACI International (CACI) remains my top cybersecurity recommendation. The company has firmly established itself with many government agencies and numerous private companies as their IT specialist. I believe CACI International is better positioned than any other company in its field to prosper in the cyber security industry over the long-term.
The ETFMG Prime Cyber Security ETF (HACK) and the First Trust Nasdaq Cybersecurity ETF (CIBR) funds offer investors a diversified way to participate in the growth of this industry.
Conservative investors should choose ETFMG Prime that tracks both blue chip and smaller cybersecurity companies. Somewhat more aggressive investors should choose First Trust Nasdaq Cybersecurity, which invests primarily in Nasdaq suppliers.
