Sector Outlook: Defense Stocks

Now that the nearly $800 billion Stimulus Package is signed into a law, the question is how its provisions would affect the different industries, which companies would present attractive investment opportunities and which ones we should avoid. After discussing the possible effects on the Solar Industry, we now take a look at the Defense Industry.

Defense companies have enjoyed an abundance of government funding over the last several years. The estimated Defense Military outlays for 2009 are approximately 650 Billion, more than double the amount of the last budget before 9/11. As a result, companies involved with defense, homeland security and aerospace have outperformed the broader markets, with the SPADE® Defense Index (DXS) beating the S&P500 Index by 80.3% cumulatively for the 9/10/01 – 2/23/09 period.

However, this process may be coming to an end. Although historically, defense spending has not been much correlated with trends in the overall economy, increase in government deficits related to recent federal bailouts and reduced tax revenue may lead to downward pressure on defense budgets. Tom Shanker of The New York Times expects the U.S. Defense department to scale back on spending, as President Obama will need to identify at least some budget cuts after signing the new stimulus bill. Weapons programs that have suffered significant cost overruns are amongst the most likely to be affected, according to Mr. Shanker.

Although supplemental funding for weapons procurement and R&D is expected to decrease going forward, there is normally a lag between defense funding and the actual delivery of the purchased equipment. The Aerospace Industries Association estimates that since new procurement spending is basically committed for fiscal year 2009, and the new administration will have limited impact on fiscal year 2010, aerospace companies should see defense sales growth continue on-pace through calendar year 2012.

Whether the expected negative impact for the overall industry would come sooner or later, the key would be to identify which companies within it are relatively overvalued and most likely to suffer a severe price correction, and which have low market expectations embedded in their current stock price, thus being under lower pressure for meeting and beating analysts performance benchmarks.

Listed below are the companies from the Defense Industry according to AFG sector industry classification. Accompanying each stock, are its respective market cap, P/B, forward P/E, and sales growth expectations priced into the stock utilizing AFG’s Value Expectation application (assuming their 5-yr median EBITDA margins and asset turnover levels remain constant in the next 5 years).

Defense Companies and Their Implied Sales Growth Expectations (click to enlarge):

Comments

[Jim Hawthorne:]

As the Obama administration moves to reduce military spending, there is no doubt that broad government spending for 'big ticket' defense contractors will decline, and this will impact the sector...

Niche Aerospace/Defense OEM suppliers like BCZ, ADG, SVT, ESLT might offer better buys down the road a bit.

Feb 24 09:19 AM

[Scott Sacknoff:]

According to the most recent "Defense News", the top line budget for FY2010 is $537 billion up from $513 billion; a gain of 4.7%. Details on line items and the amount going to specific procurement and R&D items have not yet been released.

Feb 24 09:30 AM

[drone:]

I wouldn't put a penny into any of these stocks given the taxpayer dollars they misappropriate and the misery they cause to so many people in the world.

Feb 24 11:25 AM

[drone:]

The US Fourth Fleet recently sailed down the west coast of South America. They had nothing better to do so why not go on a joy ride, flex some muscles. They sailed down there, turned around and came back. Now what? What will it do next? Boys and their toys!

Recently the navy commissioned a new aircraft carrier, the George H.W. Bush. It's worth a few billion dollars so we can't just let it go wandering off on its own. It requires the protection of numerous battleships, destroyers, convoys, which also cost billions.

What will this multi billion dollar battle group do when it is finished? Patrol the west coast of Canada to make sure they don't steal our salmon and protect American fishermen while they steal Canadian salmon.

Feb 24 07:40 PM

[drone:]

We already have a huge fleet of F15 fighter jets which are light years ahead of the competition, capable of doing incredible damage unopposed anywhere they are sent. But we are now being told that they are getting old so we need the F22. This new jet has insect-like agility combined with human intelligence and can't be seen with conventional radar. We will scrap those old F15's and get that new jet at a cost of multi billions of dollars.

Feb 25 06:00 AM

[tedster98:]

Spoken like a true leftist moron who wouldn't know the joy of people liberated from despotic tyranny and radical regimes.


On Feb 24 11:25 AM Borscht wrote:

> I wouldn't put a penny into any of these stocks given the taxpayer
> dollars they misappropriate and the misery they cause to so many
> people in the world.

Mar 01 03:10 PM