The Budget Sequester Could Create Buying Opportunities In These 2 Stocks

Includes: GD, IRDM
by: Hawkinvest

March 1 is just about two weeks away and unless Congress intervenes very soon, it looks like automatic spending cuts or "sequestration" is going to take effect. These government cuts will impact a wide variety of programs and sectors, which range from airport security to education, but the defense budget will be hit the most. Half of the spending cuts will occur in defense and according to some reports, this could result in the smallest ground force since before World War II, the smallest Navy since before World War I, the smallest tactical fighter force in the history of the Air Force, and the smallest civilian workforce in the history of the Defense Department. The cuts are estimated to be around $492 billion over the next 10 years.

As we rapidly approach March 1, investors might increasingly cut exposure to this sector by selling stock in companies that rely on Defense Department spending. It seems clear that many companies will be impacted by the reality of the U.S. Government's massive debt load for years to come. However, a significant market correction or a correction in defense-related stocks could present a buying opportunity in the near term for investors who have a longer time horizon. Here are a couple of stocks that might be poised to drop in the coming weeks and may be worth buying in a pullback:

Iridium Communications (NASDAQ:IRDM) operates a network of satellites, which provide nearly seamless coverage for telecommunications globally. Satellite-based communications are needed in a number of special situations and one of Iridium's largest customers is the Department of Defense. The company website states "The U.S. Department of Defense, through its own dedicated gateway, relies on Iridium for global communications capabilities." In fact, the Department of Defense represents about 23% of Iridium's revenues and other government agencies are also major customers. This could potentially be a problem for the company and create a challenging environment in the coming months.

Just a few weeks ago, Iridium shares were trading below $6, but have since rallied to around $7. Iridium plans to release fourth-quarter earnings on February 28, and if results are weaker than expected or if the company provides disappointing guidance due to the anticipated government spending cuts, investors might hit the sell button. If the stock drops back below $6, it would appear to be a solid buying opportunity for longer-term investors since the company is a leader in this industry. Furthermore, it is planning a satellite-based aviation tracking network, which could help diversify the revenue and customer base in the future.

Here are some key points for IRDM:
Current share price: $6.86
The 52-week range is $5.25 to $9.73
Earnings estimates for 2012: 84 cents per share
Earnings estimates for 2013: 96 cents per share
Annual dividend: n/a

General Dynamics (NYSE:GD) is a leading defense contractor and it offers a range of products, which include combat vehicles, weapons systems and munitions, as well as ships. These lines of business could be significantly impacted by government budget cuts in the coming years. Unlike some major defense contractors, General Dynamics does have some diversification outside of the defense sector as it manufactures
Gulfstream business jets. These jets are popular with corporations and wealthy individuals, especially as commercial airline travel becomes increasingly cumbersome with security requirements. The Gulfstream division could (slightly) help buffer revenue and profit margins pressures on the defense side for General Dynamics and it adds long-term growth potential.

During past sell-offs in the last 12 months or so, General Dynamics
shares have bottomed out around $60. That means this could be a key support level and investors may want to consider buying a pullback to about $60 if defense stocks see a correction in the coming weeks. General Dynamics recently reported a loss of $6.07 per share, which was primarily due to a $2 billion non-cash charge for its information systems business. For 2012, the company lost $332 million due to the one-time charges, but it earned a profit of $6.48 per share when these charges are excluded. The company has provided earnings guidance for 2013 to come in between $6.60 to $6.70. The question for investors is whether or not the defense spending cuts will be worse than expected. If so, earnings estimates could be too high. However, if these forecasts hold, the stock looks like a good buy around $60 as it would be trading for about 9 times earnings and at a key support level, which means additional downside might be limited.

Here are some key points for GD:
Current share price: $66.60
The 52-week range is $61.09 to $74.54
Earnings (actual) for 2012: $6.48 per share (excluding one time charges)
Earnings estimates for 2013: $6.60 per share
Annual dividend: $2.04 per share, which yields 3.1%

Data sourced from Yahoo Finance. No guarantees or representations are made.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.