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  1. Home
  2. / Investing
  3. / Stocks

Aim for High Dividends: 3 Defense Stocks for Tough Times

Military contractors tend to have strong performance, even amid recessions. Here are three names that could provide steady income now.
By BOB CIURA
Oct 01, 2022 | 07:30 AM EDT
Stocks quotes in this article: ITA, GD, LMT, HII, NOC

In tumultuous periods like this, risk-averse investors look for stocks that are resilient to bear markets. Look no further than defense stocks. These have typically outperformed the broad market during such rough times. The iShares U.S. Aerospace & Defense exchange-traded fund (ITA)  has declined only 11% this year, whereas the S&P 500 has shed 24%. It is also important to note that defense stocks have outperformed the S&P 500 over the last decade (+178% vs. +150%).

In this article, we will discuss the prospects of three resilient defense stocks, which offer reliable dividends.

Dynamic Trading: General Dynamics

General Dynamics (GD) is an aerospace and defense company that operates in four business segments: Aerospace (21% of sales), Combat Systems (19%), Marine Systems (26%), and Technologies (34%). Based on revenue, General Dynamics is the fourth-largest defense company.

General Dynamics is an entrenched military prime contractor. It has ground and marine platforms that serve as the backbone for the Army and Navy, and militaries around the world. These platforms have decades-long life cycles and General Dynamics has the expertise to maintain and modernize them. These characteristics comprise a significant competitive advantage and result in resilience to recessions.

On the other hand, General Dynamics is susceptible to program cuts and budget cuts by the Department of Defense. The company is trying to increase its exposure to information technology and cybersecurity in an effort to identify new growth drivers. However, these fields are characterized by more intense competition and hence they have lower operating margins.

The strength of the business model of General Dynamics is clearly reflected in its exceptional performance record. The company has grown its earnings per share every single year over the last decade, with the exception of an 8% decrease in 2020 due to the pandemic. An 8% decrease in earnings per share in one of the fiercest downturns in history, in which many companies saw their earnings collapse, is a testament to the resilience of General Dynamics to downturns.

During the last decade, the company has grown its earnings per share at a 6.6% average annual rate. This growth rate may not seem exciting but it is certainly attractive, given the consistency of the company and its resilience to recessions.

Moreover, General Dynamics has fully recovered from the pandemic and enjoys positive business momentum right now. The company grew its earnings per share by 5% in the most recent quarter and thus it is on track to grow its annual earnings per share by about 5% in 2022, to a new all-time high. In addition, it has grown its backlog to $87.6 billion, which is 2.3 times the annual revenues of the company. The excessive backlog certainly bodes well for future growth prospects.

It is also worth noting that General Dynamics is a Dividend Aristocrat, with 31 consecutive years of dividend growth. The company has grown its dividend by 10% per year on average over the last decade and by 9% per year over the last five years. Moreover, the stock is currently offering a 2.3% dividend yield. Given its healthy payout ratio of 41%, its rock-solid balance sheet and its reliable growth trajectory, General Dynamics can easily continue raising its dividend meaningfully for many more years.

Lock Into Lockheed Martin

Lockheed Martin (LMT) is the largest defense company in the world. It generates approximately 60% of its revenues from the Department of Defense, and 10% more from other U.S. government agencies and the remainder from international clients. Its aeronautics segment, which generates about 40% of total sales, produces well-known military aircraft, such as the F-35, F-22, F-16 and C-130.

Just like General Dynamics, Lockheed Martin is an established military contractor. It has developed the expertise to modernize its platforms and thus the latter have a useful lifetime of decades. Thanks to its dominant position in its business, Lockheed Martin has proved resilient to recessions. On the other hand, the company does face some risks from government budget cuts from time to time. For instance, changing administrations can adversely affect defense budgets.

Lockheed Martin is currently facing headwinds from the exit from Afghanistan and some completed contracts. On the other hand, it greatly benefits from the ongoing war in Ukraine, which has significantly increased the demand for the military equipment of the company.

Lockheed Martin faces weak competitive forces in its business, as there are very few companies, which should satisfy the military needs of all the countries in the world. This helps explain the strong performance record of the company. During the last decade, Lockheed Martin has grown its earnings per share every single year except for 2020 due to the pandemic. It has grown its earnings per share at an 11.8% average annual rate throughout this period.

Moreover, the invasion of Russia in Ukraine this year seems to have increased military instability in some regions of the globe, as a few other countries may attempt to imitate Russia. This is a potential future tailwind for Lockheed Martin.

Lockheed Martin has raised its dividend for 20 consecutive years and hence it is an appealing candidate for the portfolios of income-oriented investors. It has grown its dividend by 11% per year on average over the last decade and by 9% per year over the last five years. These growth rates exceed the 8% median dividend growth rate of the defense sector over the last five and ten years.

Moreover, Lockheed Martin is currently offering a 2.8% dividend yield, with a solid payout ratio of 52%. Given also its strong balance sheet and its resilience to recessions, the company is likely to continue raising its dividend meaningfully for many more years.

Say HII to Huntington Ingalls Industries 

Huntington Ingalls Industries (HII) was spun out of Northrop Grumman (NOC)  in a tax-free transaction in 2011. The company primarily builds nuclear and non-nuclear ships for the U.S. Navy.

Huntington Ingalls has an entrenched position in its end markets. Its main competitive advantage is its expertise in designing and fabricating bespoke ships for the U.S. Navy. This expertise is not easy to replicate and hence the company enjoys a wide business moat. Indeed, in the U.S., the company is the only provider of nuclear aircraft carriers, one of the two providers of nuclear submarines and the only provider of amphibious assault ships. Thanks to its wide business moat, Huntington Ingalls has proved resilient to economic downturns.

Huntington Ingalls has grown its earnings per share by 12.7% per year on average over the last eight years. This growth rate exceeds the growth rate of the other two defense companies, mostly thanks to the much smaller size of Huntington Ingalls, which makes it easier to grow, and the wide business moat in its business. On the other hand, the superior consistency of the other two defense companies should not be undermined.

Huntington Ingalls has promising growth prospects. The Pentagon is spending heavily on aircraft carriers, nuclear submarines and amphibious assault ships while the U.S. Navy has a goal of 355 ships by 2034. Huntington Ingalls will undoubtedly benefit from these growth drivers.

Moreover, Huntington Ingalls has raised its dividend for 10 consecutive years. It has a solid payout ratio of 34% and a decent balance sheet and hence it can easily extend its dividend growth streak for many more years.

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At the time of publication, Ciura had no position in any security mentioned.

TAGS: Accounting | Dividends | Investing | Stocks | Defense

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