The Defense Sector Yields Too Much To Ignore

 |  Includes: BA, GD, LMT, NOC, RTN
by: Stone Fox Capital

Nothing like taking a financially strong sector combined with fears of cutbacks to provide for some exciting yields.

With major government budget cutbacks expected in the US, the defense sector went through a few rough quarters in 2011. Investors feared the worse. At the end of the day though, the companies remain strong and according to a Bloomberg report, most of the top dividend yielding stocks in the Capital Goods sector belong to the defense sector.

Figure 1 - S&P 500 Capital Goods Top Dividend Yields

Stock Company Div % Declared Div
Payout Ratio
LMT Lockheed Martin 4.51 1.00 40.9
GE General Electric 3.55 0.17 57.5
RTN Raytheon 3.40 0.43 32.4
NOC Northrop Grumman 3.34 0.50 26.0
EMR Emerson Electric 3.16 0.40 42.3
Click to enlarge

According to the Stockholm International Peace Research Institute's annual statistics, Lockheed Martin (NYSE:LMT), Northrop Grumman (NYSE:NOC), and Raytheon (NYSE:RTN) rank in the top 6 of the world's arms vendors. Other US vendors Boeing (NYSE:BA) and General Dynamics (NYSE:GD) rank in the top 6 and have solid 2%+ dividends as well.

All of these companies also benefit from the beginning of a new aerospace cycle to counteract some of the decline in defense spending.

Better yet though, is that this sector is so flush with cash that the leading dividend companies spent 2011 buying back stock. As Figure 2 shows below, these stocks are now providing some phenomenal net payout yields (NPY).

Figure 2 - Net Payout Yields

Stock Div Yield % Buyback Yield % NPY %
NOC 3.34 14.79 18.13
LMT 4.51 7.86 12.37
RTN 3.40 6.30 9.70
Click to enlarge

Another sign that analysts have been too quick to write them off is that all 3 companies beat Q4'11 earnings estimates on average by 17%. No wonder the companies were buying stock at alarming rates.

To be fair, the future isn't all roses with analysts expecting declining revenue for the next few years. Oddly though, the declining revenue isn't leading to dramatically lower earnings. These companies have been able to get ahead of an margin compression problems.

Also worth noting was the news from China over the weekend. With the Chinese expanding military spending by 11%, the long term pressure to maintain a strong military will remain.

Management of these defense firms were attempting to alert investors that wanted to listen. Cash flow potential remains a lot higher than most investors realized especially compared to the market value.

These stocks have run up with the market in 2012, but yields remain very attractive. The 18% yield on Northrop Grumman is practically too good to pass up.

Disclosure: I am long LMT, RTN.

Additional disclosure: Please consult your financial advisor before making any investment decisions.