Trends Expected To Continue With Defense Stocks

Includes: COL, HON
by: Matthew Potter

Analysts are expecting flat results from defense contractors as they report their first quarter earnings over the next few weeks. Trepidation about potential reductions in defense spending starting with next year's budget is moderating predictions and enthusiasm for much growth in revenue and earnings. Over the last year, most of the large defense industrials have seen flat revenue, but some increase in earnings as cost cutting has moved to the fore.

Some of the companies reporting last week illustrate this trend.

Honeywell International (HON)

Honeywell provides both products and services to the Defense Department and many commercial businesses. It makes engines for military vehicles and aircraft as well as components. The company also does decent business through logistics management of its products and systems in combat theaters and the U.S. Similar to other companies the ups-and-downs of the commercial aviation manufacturing and air transport industries may have a serious effect on their earnings and revenue.

For the most recent quarter, Honeywell did fairly well. Sales increased 7% driven by commercial aerospace and the group that supports the oil and gas industry. Earnings per share from continuing operations were up a robust 21% to over a dollar. The company is raising its full year guidance and now expects EPS at $4.35-4.55 or up nickel to a dime. Sales expectations held steady in the $38 billion range.

Over the last three months, the stock price has steadily increased. It peaked at a little over $62 at the end of March. It dropped with the overall market but with the announcement of this quarter's earnings it is up to $59.39 on Friday. This makes it one of the few stocks that have beaten the market these last two weeks. Honeywell's dividend is $1.49 for the year, making it fairly high compared to its peers.

Honeywell will most likely continue this good performance, thanks to the boom in the world and U.S. oil and gas production. Defense related products are going to have to wait and see how the defense budget falls out over the next twelve months. Even so, this might be one stock in this group that could provide decent performance.

Rockwell Collins (COL)

This Indiana-based company, a diverse manufacturer of aviation components and defense services, reported growth in its net income for the second quarter. Earnings per share came in at $1.09 or up nearly 14%. This was on total sales of just over $1 billion, which was a decline of 5% from last year. Like many other companies that share commercial and government sales, Rockwell offset reductions in defense spending by improved commercial activity, although not enough to prevent the overall change in revenue. For the whole year, the company is now lowering its predictions to $4.40 to $4.60 a share. Like other companies in its market, Rockwell is also buying back shares and increasing dividends.

Stock performance over the last three months has been flat. It closed on Friday at $55.56, which is about $9 below its 52-week high and $12 above the 52-week low. The stock mirrored many others in the market by showing large growth last fall. Growth that has not continued and it has trailed the market by 14% for the last year.

Next week we will see the four biggest defense companies report: Raytheon (NYSE:RTN), Boeing (NYSE:BA), Northrop Grumman (NYSE:NOC) and Lockheed Martin (LMT). As with many other companies, there will most likely be flat revenue with some growth in earnings. Boeing, due to its commercial product line dwarfing the others, might see a small increase. For the next twelve months, these corporations will continue to buyback stock, manage their dividends and realign their business lines to try and cushion what could be major defense cuts as the U.S. moves to try and reduce overall spending on government programs.

All of this leads one to believe stock prices will mirror the company performance and show little or no price increase. If the cuts happen next year revenue will be significantly affected with similar declines in stock performance. The sector, until it adjusts to the new paradigm in government spending, should suffer for several months.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.