North Korea makes noise, and the world jumps. Kim Jong Un, the young, unproven leader of North Korea rattles the sabers of war, the stock price of the three largest American defense contractors has also jumped. The biggest worry today is that some accident or miscalculation on the Korean peninsula could lead to war.
Ever since North Korea's petulant leader launched his latest missile test about a month ago, the United States and its allies have tightened the screws on this communist dictator and strengthened economic sanctions on his regime. This heightened tension has led to ever-increasing threats, both in number and intensity.
South Korea expects the North may launch a missile this week. Kim has moved a missile that he claims is tipped with a nuclear bomb, to the eastern coast, closer to South Korea, and threatens to launch it into the South, Japan, or even the U.S. domestic homeland. U.S. analysts believe he does not have the capacity to launch as far as the mainland, but acknowledge his ability to hit our troops in bases located in South Korea.
In a situation reminiscent of the movie, The Mouse That Roared, this unstable leader threatens the whole world with nuclear catastrophe to advance his aims, seeking economic concessions from the West, and acknowledgement of his country's right to develop its nuclear weaponry. The present situation also brings to mind the Cuban missile crisis of 1962, when Fidel Castro threatened the U.S. with a missile strike with the aid of Russian nuclear warheads based on his island.
As the saber rattling has grown louder, the stocks of the largest domestic defense contractors have rocketed steadily higher. The correlation has been quite notable.
Lockheed Martin Corporation (LMT), with 2010 sales of $45.6 billion operates in the aircraft, electronics and missiles space. Lockheed Martin is the largest arms-producing and military services company in the world. Lockheed produces a number of major products, including the Trident missile and the F-16 and F-22 fighter jets. If hostilities continue to heat up, demand for its products will grow. Just the perception of the possibility of war should keep adding to the momentum, resulting in a rising stock price. At $95.09, shares are now just shy of their 52 week high.
As the S&P has barely managed a positive return of .5% since the crisis began to intensify a month ago, LMT has gained 6.5% and trading volume has about doubled from its 3 month average.
Lockheed Martin Corporation Forecast P/E Growth rates
The projected P/E ratios for this year and next are significantly below the current P/E ratio of the S&P 500 of about 14.5, so there is plenty of room for the multiple to expand.
The Boeing Company (BA) is the world's third largest arms company. It is one of the world's major aerospace firms. The company operates in five principal segments:
• Commercial Airplanes
• Defense, Space & Security (BDS) business comprises three segments:
• Boeing Military Aircraft (BMA)
• Network & Space Systems (N&SS) and
• Global Services & Support (GS&S) and
• Boeing Capital (BCC)
The U.S. is in the process of setting up missile defense systems in Guam and South Korea with the aim of intercepting any missiles that the North may launch. Boeing, as well as the other companies mentioned here are involved in development and manufacture of such systems. Over the period of hostilities heating up, Boeing's stock has been in the process of setting new 52 week highs in after-hours trading Monday, to $86.87.
As noted in the above chart, Boeing and Lockheed Martin have been moving pretty much in lockstep, both up around 6.5% over this one month period. Trading volume on many days has exceeded its average of around 6 million shares as momentum continues to build in this name as well.
The one year chart indicates an even larger increase in momentum.
The Boeing Company Forecast of P/E Growth Rates
The sequester has weighed on investor sentiment as it impacts the revenue and profit forecast for Boeing and all defense contractors. The above chart indicates good growth this year being sliced in half next year, and a resulting decrease in the P/E ratio for 2014. Regardless, the price action in the defense sector clearly reflects the anxiety over the nuclear situation in Korea and how the market anticipates a rise in the fortunes of these companies.
Northrop Grumman Corporation (NOC) is the fourth-largest weapons contractor in the U.S. The company, which is based in Falls Church, Va., is one of the leaders in aerospace technology and the leading producer of naval vessels in the world. The company manufactures Nimitz-class carriers that are the current flagships of the U.S. Navy. The U.S. has advanced many such vessels into the area over the past weeks. Over the next few years it is also set to build the new, $9.7 billion Gerald R. Ford-class supercarriers. Northrop Grumman also develops radar systems for aircraft and ground defense, sensor systems for a variety of vehicles and several unmanned aircraft and drones.
Again, these are the types of systems that the U.S. has been deploying in an attempt to shoot down any incoming missiles that the North Koreans may launch toward our bases and our allies in the region. Unmanned drones have been employed effectively to hunt down terrorists in Afghanistan and Pakistan and keep our troops out of harm's way. Weapons systems sales accounted for 81% of company revenue in 2010. Arms sales grew by approximately $3.5 billion between 2007 and 2010.
Northrop's share price has been on a tear this past month, up almost 10%, outpacing the gain of the S&P 500 by 20 times. Volume has been surpassing its 3 month average of 1.9 million shares for the past week, almost doubling just recently. This is yet another indication that momentum is building in this name, and all three companies discussed are correlated completely as to their rise in price and volume, leaving the S&P 500 in the dust.
These three defense giants are being impacted in a very favorable way as a result of a very negative situation in the world today, and repeat a time-worn pattern that is usually quite reliable. While the whole world frets, the heat is turned up with each successive threat issuing from North Korea. These defense contractors have overcome the sequestration anxieties that threatened their livelihoods only a few weeks ago and offer up the very real potential for continued increases in stock price appreciation.
If you lean favorably towards event-driven strategy, this is one opportunity that has the potential to continue delivering profits as long as Kim Jong Un continues to turn up the heat.