Recently, Lockheed Martin (LMT), the defense department's largest supplier, warned that the industry contractors would face significant disruptions in operations and mass layoffs if additional defense spending cuts are implemented as of January 2013. The sequestration scheduled for January 2013 would add $500 billion in military cuts over the decade.
"The additional defense cuts are part of $1.2 trillion in United States budget cuts triggered after a congressional committee failed to reach agreement on other ways to reduce the cavernous federal deficit," says a Reuters report about Lockheed Martin's warning. Stifel Nicolaus, an investment research company, expects Congress to find a compromise solution that would result in smaller cuts than expected by sequestration.
The prospect of additional cuts has taken a toll on the prices of most defense industry players. Raytheon Company (RTN) has fared the best. In a recently issued note to clients, Stifel Nicolaus emphasized that defense stocks have come close to bottoming. While the defense industry stocks could still underperform in the next year, opportunities should arise to establish long-term positions at more attractive prices. The investment research firm likes Raytheon the most of the bunch, given the company's "large international business, its 3.6% dividend yield, and its relatively undersized exposure to big ticket items."
Here is a glance at the five key defense industry players whose performance is adversely affected by the defense budget austerity:
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Lockheed Martin is a US-based global aerospace, defense, security, and advanced technology company. It pays a dividend yield of 4.7% on a payout ratio of 48%. The company's peers Raytheon Co., Northrop Grumman Corporation (NOC), and General Dynamics Corporation (GD) pay dividend yields of 3.6%, 3.5%, and 3.2%, respectively. The company's EPS growth is expected to average 7.1% per year for the next five years. This compares to a 6.3% per year rate achieved over the past five years. Positive contribution to the EPS growth will come in part from share buybacks. In terms of the forward P/E, the company is undervalued relative to its peers on average. Lockheed Martin stock is changing hands at $83.45 a share, up 4.7% in a year. Fund managers Jean-Marie Eveillard (First Eagle Investment Management-see its top picks) and John Shapiro (Chieftain Capital-check out its holdings) hold notable positions in the stock.
Raytheon Co. is a technology company servicing defense, homeland security, and other government markets globally. It pays a dividend yield of 3.6% on a low payout ratio of 37%. The company's rivals Lockheed Martin, Northrop Grumman, and General Dynamics pay yields of 4.7%, 3.5%, and 3.2%, respectively. Given the United States budget cuts in the defense sector, the company's EPS growth has already been adjusted down to 8.6% per year for the next five years from nearly 15% a year over the past five years. In terms of the forward valuation, the company is valued slightly above its peers, but below its own five-year average P/E. At present, the stock is trading at $54.25 a share, up 12% on the year. Billionaires George Soros and Ray Dalio sold out their respective stakes in the company last year. Fund managers Phill Gross and Robert Atchinson (Adage Capital Management-see its top holdings) and Ron Gutfleish (Elm Ridge Capital-check out its picks) are major investors in the stock.
Northrop Grumman Corporation provides products, services, and solutions in the aerospace, electronics, and information systems industries. The company pays a dividend yield of 3.5% on a payout ratio of 29%. The company's peers Lockheed Martin Corp., Raytheon Co., and General Dynamics pay dividend yields of 4.7%, 3.6, and 3.2%, respectively. The United States defense department's fiscal axe will trim the company's EPS growth to an average of 3.7% per year for the next five years from a 10.4% rate achieved over the past five years. Based on the forward-earnings multiple, the company is valued slightly below its industry average, but above its own historical metrics. The stock is changing hands at $60.89 a share, down 9% in a year. Fund managers Joel Greenblatt and Jean-Marie Eveillard hold positions in the stock.
General Dynamics is an aerospace and defense company. It provides aviation, combat vehicles, weapons systems, military and commercial ships, and communications and information technology. The company pays a dividend yield of 3.2% on a payout ratio of 30%. The company's peers Lockheed Martin Corp., Raytheon Co., and Northrop Grumman pay dividend yields of 4.7%, 3.6%, and 3.5%, respectively. Given the United States fiscal austerity, the company's EPS is forecast to slow down to an average of 9% per year for the next five years from 10.6% realized over the past five years. In terms of its forward P/E multiple, the company is valued below its industry average and its own historical P/E metrics. The stock is changing hands at $62.00 a share, down 15.4% in a year. Billionaire Warren Buffett is an investor in the stock.
L-3 Communication Holdings Inc. (LLL) is an aerospace and defense products and services companies with customers in the defense, homeland security, aerospace, intelligence, and telecommunications industries. Currently, L-3 Communications pays a dividend yield of 2.7% on a payout ratio of 22%. Its peers Honeywell International Inc. (HON), Lockheed Martin, and Raytheon Company pay dividend yields of 2.7%, 4.7%, and 3.6%, respectively. The company is expected to see a modest growth in EPS of 3.7% per year for the next five years, due to the defense budget austerity. This is 4.4 times lower compared to the average annual growth rate realized over the past five years. Still, despite the modest growth forecast, the company's capacity to generate large annual free cash flows should remain intact. The stock is undervalued relative to its peers and its own five-year average P/E. At present, the stock is trading at $71.35 a share, down 15.6% in a year. The stock is popular with Cliff Asness (Aqr Capital Management-see its top picks), D. E. Shaw, and billionaire Jim Simons.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.