Thunder In The Desert: These 3 Defense Stocks Were On Display In Arizona

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Includes: BA, LMT, UTX
by: Mark Morelli

Summary

Don't Believe Everything You Read Or Hear: The F-35 Will Be Successful For Lockheed.

KC-46 Pegasus Should Help Drive Boeing To New Highs.

Powering It All Are United Technologies Engines.

I recently had the opportunity to travel to the Phoenix area and attend an air show at Luke Air Force Base.

While my intent wasn't to perform research I did learn a lot about the prospects for three stocks while I was there. Multiple aircraft and systems supplied by Lockheed Martin Corp. (NYSE:LMT), the Boeing Company (NYSE:BA), and United Technologies Corp. (NYSE:UTX) were on display on the ground and in the air. It was thunder in the desert and profits in the pockets of investors.

A Lightning Show

The military's newest fighter, a Lockheed F-35A Lightning II, put on quite a show flying with its WWII-era predecessor, the P-38 Lightning, in the first public Heritage Flight of the two aircraft.

Click to enlarge

Lockheed F-35A Lightning II

Source: Author

Several active duty Air Force F-35A pilots were also on hand for meet and greet sessions with the public during the show. One, with several hundred hours in the cockpit of the high tech aircraft, called it the best machine he's ever flown and it is performing much better than advertised.

The Air Force "A" version featured at the show will be ready for combat by the end of the year according to the service. The Marine "B" variant was operationally certified last year and the Navy "C" model will be taking off from carriers by the end of the decade. All will be powered by the 5th generation F135 engine supplied by the Pratt & Whitney division of United Technologies.

The F-35 has gotten lots of bad press. Cost and schedule overruns and technical glitches have been widely reported. However, more than one pilot at Luke told me to not necessarily believe everything in the media.

Most of the hardware problems have been solved and the costs are rapidly coming down. In fact the invoice for the latest unit delivered to the Air Force was less than $100M for the first time ever. Subsequent aircraft will be even less expensive, approaching the cost for the latest souped-up Lockheed F-16V. All F-16s will eventually be replaced in the Air Force fleet by the F-35.

All this is good news to taxpayers, the government, and Lockheed shareholders. A product, the most important for the company for the foreseeable future, that meets the needs of the end customer will likely be very successful, and profitable.

Lockheed has a lot of other good things going for it including a reasonable valuation with a P/E of 19.7 and a juicy dividend with a current yield of 2.94%. Based upon expected earnings growth, a relatively manageable debt, and a payout ratio of 55% the dividend is likely to keep growing as well.

A masterful performance

Boeing, probably better known for its commercial jets such as the long-haul 787 Dreamliner and the narrowbody 737, had numerous aircraft on hand including a C-17A GlobeMaster III cargo plane, a B-1B Lancer supersonic bomber (the program was inherited when Boeing acquired Rockwell International), a KC-135 tanker, and a F-15C Eagle air-air dogfighter.

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Boeing C-17A GlobeMaster III with Pratt F117 powerplants

Source: Author

Boeing is currently developing a replacement for the nearly 60 year-old KC-135, called the KC-46A Pegasus, which will feature military versions of the Pratt PW4000 commercial engine. That will keep Boeing's factory in Washington state going for some time, and lots of cash in the pockets of investors.

Deliveries of military aircraft and systems account for just 14% of revenue for the Chicago-based Boeing but there is a lot of synergy between the defense-related work and the more important commercial side of the business which really drives the bottom line. For example, the Pegasus tanker is based upon the popular 767 passenger jet.

Between the military work and heady growth in commercial aircraft needed over the next two decades Boeing shareholders should be in the black for a long time.

Boeing also has the financial fundamentals in place right now. The stock is fairly valued at a P/E of 17. Shareholders receive a competitive dividend payment every quarter. The yield is 3.4% and the 3-year growth rate has been 20%.

High powered revenue streams

United Technologies was also well represented at the show, and in fact was one of its major sponsors.

The Thunderbirds, the Air Force demonstration squadron flew specialized versions of the F-16 with Block 52 aircraft featuring the powerful Pratt F100-PW229 engine. A group of five other F-16s performed a simulated close air support mission showcasing the Pratt engines as well.

The Boeing C-17 on display featured four Pratt F117 engines and the Lockheed F-22 (parked between two F-35s on the tarmac) had two Pratt F119 powerplants at its rear end. While these aircraft are no longer in production spare parts and service will still be needed for many more years which should provide a nice revenue stream for UTX and dividends for its shareholders. The F-15 Eagle also uses Pratt F-100s.

In addition to the upcoming Pegasus and ongoing F-35 work another positive for UTX was that Pratt was recently awarded a contract to begin development of the engines that will power the next generation bomber, the B-21, which will handle the role now served by the ageless B-52 Stratofortress. The success Pratt achieved on the F-22 and F-35 programs was likely the catalyst for being selected.

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Lockheed F-35A Lightning II with Pratt F135 powerplant

Source: Author

Military aerospace will continue to be an important part of United Technologies' business for many years to come.

Conclusion

As a result of my recent trip to Arizona I was able to watch aircraft and systems supplied by Lockheed, Boeing, and United Technologies in action and speak to the people, the pilots, that know the equipment better than most. Investors might want to take a look at these companies too.

Disclosure: I am/we are long UTX.

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.