Which Stocks You Should Be Picking Amid Defense Budget Cuts

Includes: GD, NOC, RTN
by: Fusion Research

The aerospace and defense industry, or A&D, reported its best results ever in 2012. The revenue of "Top 100 A&D companies" reached $695 billion, which was up by 4% year over year, and profits hit $59.8 billion, up 2% in the same period last year. Fueled by the rising world air traffic, the commercial aviation market propelled industry growth. This, also compensated for the slowdown in the defense sector -- due to a decline in defense spending.

Three A&D stocks, listed among the world's top 10 defense contractors, are trying to sustain their leadership by gaining new contracts, reducing dependence on the U.S. market, and capitalizing on growth in the aerospace segment.

Diversification with new contracts

During the second quarter of 2013, Raytheon (NYSE:RTN) posted 10% year over year sales growth from the international market, which contributed 27% of its total sales. New orders, like a $275 million contract from Oman and Saudi Arabia for its missile system and a $93 million contract from Australia for in-service support, are helping the company diversify its client base.

The following orders are expected to help Raytheon sustain this revenue growth:


System Ordered

Deal Value


Patriot Missile System

$2 billion


Patriot Missile System

$500 million- $700 million


Air defense system

$1 billion-$1.5 billion

Based on these potential orders, Raytheon looks all set to increase its international revenue contribution from 26% in 2012 to 31% in 2013. This will also reduce its dependence on the U.S. government for new orders.

Raytheon's space and airborne systems division is expecting revenue growth from the U.S. Navy contracts. Recently, the company received a contract worth $279.4 million for its next-generation jammer, which will replace the old ALQ-99 tactical jamming system in the Navy's EA-18G aircraft. The next generation jammer provides an advanced technology system to aircraft, which jams the enemy's radar signal during electronic warfare.

The company's leadership in advanced electronic systems is expected to result in additional contracts worth $2 billion from the U.S. Navy in the coming years. The management expects the division's revenue to increase from $5.33 billion in 2012 to $6.55 billion in 2013.

Smooth Sailing and Clear Skies Ahead

In the second quarter of 2013, General Dynamics (NYSE:GD) announced revenue growth of 29% year over year in its aerospace business segment.

There is a strong demand for Gulfstream's G650 series aircraft, built by General Dynamics' wholly owned subsidiary Gulfstream Aerospace. Buyers apparently appreciate Gulfstream's features like broad cabin space and the fastest speed among all civilian jets. The company has a total backlog of 200 G650 aircraft, and plans to deliver 28 aircraft in 2013, 40 in 2014, and 45 in 2015. This robust demand for G650s is expected to increase the segment's revenue to $8.02 billion in 2013, up 16% year over year.

Apart from aerospace, the company is also expecting marine segment revenue growth to continue in 2013. General Dynamics received new orders from the U.S. Navy in the second quarter of this year, including a $2.8 billion order for construction of four DDG-51 ships.

With the new contracts, General Dynamics' marine segment revenue growth is expected to increase from $6.59 billion in 2012 to $6.71 billion in 2013.

Big impact from U.S. defense cuts

Recently, the U.S. Navy awarded Northrop Grumman (NYSE:NOC) a $617 million contract to supply five E-2D Advanced Hawkeye aircraft. These aircraft provide the Navy with airborne early warning signals and battle management services.

This provides some respite towards Northrop's future growth prospects, which will be severely impacted by the U.S. defense budget cuts. With the U.S. government contributing 90% of the company's revenue, these budget cuts are expected to affect Northrop's top line in the future. Northrop's revenue is expected to reduce from $25.22 billion in 2012 to $23.30 billion in 2014.

In May 2013, Northrop announced the issuance of a $2.85 billion debt via senior unsecured notes with different maturity dates. It will use the cash generated from this issue to redeem debt of $850 million, outstanding as the principal amount from already issued senior notes, and for other purposes like pension plan funding and share repurchase. Despite partial debt redemption, this issue is expected to increase its interest expense by $72 million annually.


Raytheon is focusing on international markets for new contracts, while General Dynamics is capitalizing on the robust demand for its Gulfstream aircraft. Looking at the future revenue growth opportunity in both companies, we recommend investors to buy these stocks.

Despite new contracts, over dependence on the U.S. government and new debt issues are affecting Northrop's top and bottom line. Due to the increased military cuts expected in the near future, the potential growth opportunity looks gloomy in the coming quarters. We recommend a hold on this stock for now.

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.