3 Ways Investors Can Play Defense

The U.S. Department of Defense has a budget of $705.4 billion for 2021, and spending is only expected to rise over the next several years, suggests Ben Reynolds, a leading income investing expert, the editor of Sure Dividend and a contributor to MoneyShow.com. Here, he looks at three favorite investment ideas in the aerospace and defense sector. The aerospace and defense industry generates revenue in large part from governments. U.S. defense companies profit from the U.S.'s tremendous defense budget. Surprisingly, the valuation multiples in the sector are reasonable. And some of the sector's top names have enviable growth and capital allocation records as well. L3Harris Technologies L3Harris Technologies is a $38 billion market cap aerospace and defense business that is the result of a merger between L3 Technologies and Harris Corporation. The company reports under four segments: Integrated Mission Systems; Communication Systems; Space & Airborne Systems; and Aviation Systems. Most of its sales are to the U.S. government and other defense contractors. On Jan. 29, L3Harris Technologies released full year and Q4 2020 results. For the quarter, companywide revenue declined 3.6% to $4.7 billion and diluted adjusted earnings per share (EPS) increased 10% to $3.14 on a year-over-year basis. For the year, companywide revenue increased 0.5% to $18.2 billion and diluted adjusted EPS increased 13% to $11.6. Revenue for Integrated Missions Systems was flat at $1.5 billion, revenue for Space & Airborne Systems rose 4.3% to $1.3 billion, revenue for Communications Systems increased 2.1% to $1.1 billion, and revenue for Aviation Systems fell 22% to $845 million. The company issued 2021 guidance of between 3% and 5% organic revenue growth and between $12.60 and $13.00 in EPS. As a prime U.S. defense contractor, L3Harris Technologies has an entrenched position in many of its end markets. As a result, it benefits from extensive regulatory knowledge, a significant intellectual property portfolio, and deep relationships within the Department of Defense that make it very challenging for a new entrant to compete with them for contracts. Additionally, the fact that most of its revenues come from the government makes it quite recession resistant. During the Great Financial Crisis, L3Harris Technologies' combined companies continued to raise their dividend each year. Over the past decade, the combined L3Harris Technologies companies grew EPS by a 9.7% average yearly rate. This impressive result was driven by a top line that grew by 3.3% annually, while the company's net profit margin declined from 7.3% to 6.2% and the share count grew by an average of 5.8% per year. However, the net profit margin improved significantly through 2019 and the share count declined through 2019 before expenses and share issuance related to the merger and COVID-19 headwinds temporarily distorted results in 2020. Moving forward we anticipate 10% annual EPS growth, with many of the same factors contributing to this thesis. We expect L3Harris Technologies to generate EPS of $12.80 in 2021. Based on this, the stock is currently trading at a price-to-earnings ratio (P/E) of 14.4. Our fair value estimate is a P/E of 16.0, which means expansion of the P/E multiple could add 2.2% per year to annual returns. When combined with the 10% expected growth rate and 2.2% dividend yield, total return potential comes to 14.2% per year over the next five years. Lockheed Martin Corp. Lockheed Martin is the world's largest defense company. About 60% of the company's revenues come from the U.S. Department of Defense, with other U.S. government agencies (10%) and international clients (30%) making up the remainder. The company consists of four business segments: Aeronautics (~40% sales), which produces military aircraft like the F-35, F-22, F-16 and C-130; Rotary and Mission Systems (~26% sales) -- which houses combat ships, naval electronics and helicopters; Missiles and Fire Control (~16% sales) -- which creates missile defense systems; and Space Systems (~17% sales) -- which produces satellites. Lockheed Martin reported Q4 2020 results on Jan. 26. For the quarter, companywide net sales increased 7% to $17.0 billion from $15.9 billion and EPS increased to $6.38 from $5.29 on a year-over-year basis. All four business segments increased net sales, ranging from 4% to 14% improvement. For the year, companywide net sales advanced 9% to a record $65.4 billion from $59.8 billion and EPS increased 12% to a record $24.50 from $21.95. Lockheed Martin's backlog is approximately $147.1 billion driven by increases in Aeronautics, Missiles and Fire Control, and Rotary and Mission Systems, but offset by a decline in Space. For 2021, the company expects revenue of $67.1 billion to $68.5 billion and EPS of $26.00 to $26.30. Lockheed Martin is an entrenched military contractor. It produces aircraft and other platforms that serve as the backbone for the U.S. military and other militaries around the world. This leads to a competitive advantage as any new technologies would have to significantly outperform existing platforms. These platforms have decades long life cycles and Lockheed Martin has the expertise and experience to perform sustainment and modernization. In addition, these characteristics lead to a good degree of recession resistance. During the 2008 through 2011 period, Lockheed Martin generated EPS of $7.86, $7.78, $7.23 and $7.82, respectively, while the dividend kept on increasing. In the 2011 through 2020 period, Lockheed Martin grew its EPS by a 13.5% average annual compound rate. This result was driven by 3.9% yearly revenue growth that was significantly aided by a profit margin increasing from 5.7% to 10.5% and a share count that declined by 1.6% per year. Moving forward we expect 8% annual EPS growth, with help from many of the same factors. We expect Lockheed Martin to generate EPS of $26.15 in 2021. Based on this, the stock is currently trading at a P/E of 12.9. Our fair value estimate is a P/E of 16.0, which means expansion of the P/E multiple could increase returns by 4.3% per year. When combined with the 8% anticipated EPS growth rate and 3.1% starting yield, total return potential comes to 15.0% per year over the next half decade. Northrop Grumman Northrop Grumman is a $50 billion market cap aerospace and defense business. The company reports under four segments: Aeronautics Systems (aircraft and UAVs); Mission Systems (radars, sensors and systems for surveillance and targeting); Defense Systems (information technology, sustainment and modernization, directed energy, tactical weapons); and Space Systems (missile defense, space systems, hypersonics, and space launchers). The company makes the B-2 Spirit stealth bomber, E-2D Advanced Hawkeye and E-8C JSTARS and provide content on the F-35 Lightning II and F/A-18 Super Hornet. On Jan. 28, Northrop Grumman released full year and fourth-quarter 2020 results. For the quarter, companywide revenue increased 17% to $10.2 billion and diluted adjusted EPS increased 16% to $6.59 on a year-over-year basis. For the year, companywide revenue increased 9% to $36.8 billion and diluted adjusted EPS advanced 11.5% to $23.65. Revenue for Aeronautics Systems increased 24% to $3.5 billion, revenue for Defense Systems rose 2% to $1.9 billion, revenue for Mission Systems increased 10% to $2.7 billion, and revenue for Space Systems advanced 31% to $2.6 billion. The company won $52.9 billion in contracts in 2020 with a book-to-bill ratio of 1.4 and total backlog increased 25% to $81.0 billion at year end. Northrop Grumman is selling its IT Services business for $3.4 billion, which will be used for share buybacks and retiring debt. The company issued 2021 guidance of between $35.1 billion and $35.5 billion in sales and between $23.15 and $23.65 in EPS. As a prime U.S. defense contractor, Northrop Grumman has an entrenched position in many of its end markets. Of note are the B-2, B-21, E-2D, E-8C, Global Hawk and Triton platforms. These platforms have decades-long life cycles and Northrop Grumman has the expertise to perform sustainment and modernization. These characteristics allow for a good deal of ballast in lesser times. During the last recession, Northrop Grumman generated EPS of $5.32, $4.87, $5.80 and $7.41, respectively, between 2008 and 2011, while the company continued to increase its dividend. Over the past decade, Northrop Grumman grew its EPS by a 12.3% average yearly rate. This impressive result was driven by a top line that grew by 3.4% annually, while the company's net profit margin increased from 8.0% to 8.7% and the share count was reduced by an average of 4% per year. Moving forward we anticipate 8% annual EPS growth, with many of the same factors contributing to this thesis. We expected Northrop Grumman to generate EPS of $23.40 in 2021. Based on this, the stock is currently trading at a P/E of 12.7. Our fair value estimate is a P/E of 15.0, which means expansion of the P/E multiple could add 3.4% per year to annual returns. When combined with the 8.0% expected growth rate and 1.9% dividend yield, total return potential comes to 13.2% per year over the next five years. Subscribe to Sure Dividend here: https://www.suredividend.com/

3 Ways Investors Can Play Defense

An in-depth look at a trio of leading aerospace & defense stocks, with all offering a combination of strong growth and solid income.

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