Thus far in 2022, geopolitics are arguably playing a larger part in investment theses than at any point since the U.S.-led invasion of Iraq two decades ago.
Energy, finance, and more have all been affected by Russia's unexpected full-scale invasion of Ukraine. While unspeakable tragedy is unleashed in Ukraine and markets crash in Moscow amid a Western response, the world has been woken up to the need to spend on defense. Given this dynamic, investors would be wise to look at shares of major defense stocks as well.
There are many companies to consider amid this paradigm shift, including names such as Northrop Grumman (NOC) , Boeing (BA) , Lockheed Martin (LMT) , Textron (TXT) , L3Harris Technologies (LHX) and General Dynamics (GD) . Almost all of these firms are storied, profitable, and not excessively pricey despite a recent broader pop in shares.
Yet, at the moment, Raytheon Technologies (RTX) appears to me to be the top pick to set your sights on.
Europe's Bigger Budgets
While U.S. investors are clearly vigilant, I can attest that the attention in Europe is overwhelmingly focused on the largest military conflict on the continent since 1945. However, in contrast to 1945, the major powers of Central Europe are eager to link arms with the U.S. and shore up long-neglected militaries.
"We need aeroplanes that fly, ships that can set out to sea, and soldiers who are optimally equipped for their missions," newly minted German Chancellor Olaf Scholz said in a speech to the Bundestag signaling a foreign policy zeitenwende. "It is quite certainly something that a country of our size and our significance within Europe should be able to achieve."
In pursuing these aims, the Bundestag approved a €100 billion fund for defense spending, an unprecedented spike in modern Germany. Likewise, the chancellor pledged to meet NATO standards in terms of defense spending as a percentage of national GDP.
Already, German Defense Minister Christine Lambrecht announced a plan to purchase 35 F-35 jets to replace its Cold War relic Tornado fighters. The flashy purchase of the Lockheed-made jets are likely to be merely the beginning as Germany's military seeks to update while nations such as Poland, Slovakia, Czechia, and more all look to add to their arsenals as well.
In terms of aiding Ukraine itself, maybe no weapon has proved as successful as the Javelin, a joint venture of Lockheed and Raytheon. Indeed, the response among Ukrainian fighters to the weapon has been so positive that images of "St. Javelin" have been jokingly cropping up across the country and even in its neighbors. Along with the Javelin missiles, Raytheon's Stinger missiles have proven popular.
As for more modern defense, the company's Patriot Missile systems have also been parked at the Polish-Ukrainian border, ready to defend NATO soil should war spread beyond the Ukrainian border, supplementing Polish stocks of the weapons that already amounted to billions of dollars worth of missiles.
"Everything that's being shipped into Ukraine today, of course, is coming out of stockpiles, either at DoD or from our NATO allies, and that's all great news," Raytheon CEO Greg Hayes said in an interview with Harvard Business School on Friday. "Eventually we'll have to replenish it and we will see a benefit to the business over the next coming years."
For reference, the company reported a backlog of $156 billion in January, with defense making up $63 billion of this sum. As the war drags on and the U.S.' European allies eagerly add to defense, the added benefit to an already bulky backlog could be quite a big one indeed. That is not to mention the potentially major spending programs that NATO membership for potential candidates like Finland and Sweden would spell.
Deep Pockets at DoD
Of course, the U.S. is not going to be outspent by its European peers.
In fact, in a bill passed in mid-March, the U.S. Department of Defense was granted a $6.5 billion budget for aid to Ukraine, which included significant funding for the replenishment of U.S. weapons and equipment stocks. Given the popularity and effectiveness of Raytheon's provisions, it stands to reason that more orders are on the way.
Along with this direct aid to Ukraine, the omnibus Consolidated Appropriations Act seeks to authorize a whopping $773 billion in discretionary spending to the department overall, a significant increase from years prior. That is not the end of the budget wrangling either, as President Biden stated.
"I'm calling for one of the largest investments in our national security in history, with the funds needed to ensure that our military remains the best-prepared, best-trained, best-equipped military in the world," Biden said in a statement on Monday. "In addition, I'm calling for continued investment to forcefully respond to Putin's aggression against Ukraine with U.S. support for Ukraine's economic, humanitarian, and security needs."
While Putin's aggression is of course a cause for allocating funds for European partners in need, it also sets sights on deterrence in the Indo-Pacific. This region is likely to only loom more tumultuous moving forward, namely over the issue of Taiwan.
"Our budget reflects our National Defense Strategy and the focus of that strategy on the pacing challenge of China," Secretary of Defense Lloyd Austin said on Monday, making this issue clear. "It absolutely supports our policy of U.S. global leadership of -- and responsibility for -- our vast network of alliances and partnerships."
In short, a world that bifurcates back toward a Cold War framework, albeit with major and important caveats, means defense spending is not going to be reined in anytime soon.
Heading Toward Hypersonic
In terms of an arms race, the most important factor at present appears to be hypsersonic capabilities. As Real Money's Stephen 'Sarge" Guilfoyle frequently discusses, both Russia and China are currently ahead of the U.S. in this arena and the former has already deployed this capability within the confines of combat with Ukraine.
"You'll notice, [Russia has] just launched the hypersonic missile, because it's the only thing that they can get through with absolute certainty," President Biden said last week, acknowledging Russia's capabilities. "It's a consequential weapon... it's almost impossible to stop it."
The "almost" is an important caveat as Raytheon is rapidly developing the world's first anti-hypersonic missile defense system, the Glide Phase Interceptor (GPI).
"Raytheon Technologies systems are the cornerstone of today's ballistic missile defenses. We're building on that knowledge to advance the missile defense system for future threats," Tay Fitzgerald, vice president of Strategic Missile Defense, said in a statement announcing strides in its development. "GPI's speed, ability to withstand extreme heat, and maneuverability will make it the first missile designed to engage this advanced threat."
Adding to its strong position in defending against China and Russia's more advanced missile systems, Raytheon also has a solid partnership with Northrop Grumman for scramjet engine technology to power hypersonic missiles offensively.
As U.S. authorities eagerly attempt to match their rivals' advancements in this frightening weapons capability, Raytheon could be a big winner given its status as a leader in engine and missile technology. If the contractor can in fact make the jump to hypersonic ahead of its main competitors, investors prescient enough to take up a position could also see some serious acceleration to the upside.
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