Military (And Portfolio) Defense: Time To Re-Up

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Includes: BA, BAESY, GD, LLL, LMT, NOC, RTN
by: Henry Miles

Summary

Geopolitical tensions continue to mount; meanwhile, terrorism has not abated.

For these reasons, military defense stocks should at least hold their value.

Also, as a substitute for Treasuries, the sector continues to remain attractive.

Eighteen months ago, I moved aggressively into four military defense stocks - General Dynamics (NYSE:GD), Lockheed Martin (NYSE:LMT), Northrop Grumman (NYSE:NOC) and Raytheon (NYSE:RTN) - reasoning that they would do well following the 2014 change-over in Congress and the anticipated end of sequestration. Back then, we were all aware of the continuing conflicts in the Middle East, North Africa and areas adjacent to Russia. We also knew that terrorism continued to leak north and west through mass-murderers well-armed with rapid-fire guns with extended clips, and bombs 'delivered' to vulnerable targets at gathering places such as night clubs, stations and promenades.

Driving Alpha-Level Returns

That investment decision was a driver for the alpha-level returns I have been experiencing. However, with the new Congress settled in and sequestration over, I began to wonder whether I should harvest some profits and selectively begin to rotate out of the sector. For the most part, it looked fully valued as these comparative price ratios suggest:

S&P BMI GD LMT NOC LMT
P/Earnings 19.68 15.48 21.40 19.95 21.20
P/E Forecast 16.84 15.10 20.81 20.51 18.88
P/Sales 1.37 1.40 1.59 1.68 1.70
P/Cash Flow 10.72 12.75 16.83 16.13 15.84
Div. Yield 1.98 2.11 2.56 1.64 2.16
Click to enlarge

I started to cull with a partial sale of Northrop Grumman on which we were up 40%. But I suddenly thought better of it, caught myself, and decided to reverse course by adding a position in BAE Systems (OTCPK:BAESY), a UK firm but a top US military defense contractor and then, recently, in Boeing (NYSE:BA). I hadn't looked at L-3 Communications (NYSE:LLL) in a while but it didn't take long to realize that I was late to that party; drat. And, I would have loved to have had a chance to consider Bluebird Aero Systems, General Atomics, Israeli Aerospace Industries and Vanguard Defense Industries but, unfortunately, they're all private.

Added to Terrorism, Geopolitical Fraying

Things continue to fray geopolitically. North Korea has ramped up their displays to include more missile tests. Tensions in the South China Sea are increasing. Japan has taken a vote that might foretell their remilitarizing. And, if all that isn't enough, along comes a coup attempt in Turkey, a country at the crossroads of all things political and economic between the east and the west, a country that borders Armenia, Azerbaijan, Bulgaria, Georgia, Greece, Iran, Iraq, Syria and through which pipelines run serving these countries and many others, and a country that has just declared a "state of emergency" with all the implications for what that may come to mean.

And, as far as the US is concerned, heads or tails, we are likely to see a new administration that leans more hawkish or, if not hawkish, some other descriptor suggesting that defense spending will be 'pushed' to allies who increase their buying of military technology and services from the US and other suppliers; check out this link regarding Saudi Arabia's and India's arms imports from the US. As I see it, military defense will be playing, er, offense for the foreseeable future.

Treasury-like Safety at Better Yields

But, there is one other important reason to consider these major companies and that has to do with financial defense in our topsy-turvy monetary world where interest rates are close to nil. If you accept the assumption that major defense contractors are inextricably tied to governments a la the "military industrial complex" then it stands to reason that the risk associated with these investments is almost indistinguishable from Treasuries. (No need to chime in with the full faith and credit distinction; I understand it.) And, if so, then I posit that investing in these companies - at dividend yields above Treasury interest rates - makes sense for investors playing, er, defense.

Play Offense and Defense

So, both for offensive and defensive reasons, it was time for me to "re-up" with military defense companies. Indeed, the sector now equals 19% of our total holdings. (This makes that book second only to our #1 strategic portfolio connected to climate change.)

Those looking at military defense stocks now should buy on pull-backs with a watchful eye on technical analysis. Given the recent run-up in most of these stocks, I generally do not see them outperforming the market. That said, Boeing and General Dynamics may offer medium-term upside because: a) They haven't participated in the sector's recent rally, b) Their price ratios are still somewhat attractive, and c) Boeing is repositioning and both firms are leading/innovating in a variety of areas including General Dynamics in the production of LNG-fueled container ships. Always consult a credentialed financial advisor who can demonstrate they add value net of their fees.

Disclosure: I am/we are long BA, BAESY, GD, LMT, NOC, RTN.

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.

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