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Big Military Budget Means Big Boon for Small Defense Contractors

|Includes:ADG, AVAV, CVU, FLIR Systems, Inc. (FLIR), GTEC, OA, OA

If you’re currently invested in the defense industry, then you probably already know the last week and a half has been much kinder to your stocks than the last month and a half. And for good reason. It was only a few days ago the market was notified of Barack Obama’s requested military budget for 2011. Despite a whole array of other things on the country’s economic plate, as it stands now, 2011’s defense budget will likely be bigger  than 2010’s; President Obama is going to ask Congress for $708 billion in 2011 to spend on the military.

That figure is surprisingly larger than the $680 million budget for 2010. Even more surprising…. it’s much greater than the $651 billion George W. Bush spent on the military in 2008.

With that as a backdrop, the 7% decline and the 2% bullish reversal we’ve seen from the Dow Jones Defense/Aerospace Index since late January all makes perfect sense. Investors assumed the Democrat President was going to reel in defense spending and use that funding elsewhere. Now it looks like he’s not.

Not that the industry is ever really in jeopardy (drastic cuts in military spending are virtually impossible), but the optimism regarding these stocks is plenty justified now…. and at least for the next couple of years. Factor in the fact that stock prices in relation to earnings - and we mean real earnings - are at levels that would make other industries salivate, and some defense exposure is a no-brainer.

The obvious choices are names like Lockheed-Martin (NYSE:LMT), Northrop Grumman (NYSE:NOC), General Dynamics (NYSE:GD), and Honeywell (NYSE:HON). Though each of those large companies are respectable in their own right, they really aren’t the strongest opportunities in the sector. The better overall possibilities come from (you guessed it) the small and micro cap names in the group.

Though we don’t want to over-generalize, the only really strong aspects the large cap equities in the defense sector offer are low P/Es, and decent dividends. Those are important, but in comparison to the growth and strong margins many of the smaller names in the sector have been generating, the Lockheed-Martin’s and the Northrop Grumman’s don’t pack any where near as much punch as, say an Alliant Techsystems (ATK) or CPI Aerostructures (NYSEMKT:CVU). Alliant Tech Systems is the U.S. military’s biggest supplier of ammunition, which may as well be food when you’re fighting a war. CPI Aerostructures builds aircraft parts, and largely serves as a subcontractor to bigger contractors.

With that in mind, we’ve got a thorough comparison of the fundamental results of the large caps in the aerospace/defense industry (which are the names you’ve heard of) versus the small caps in the industry (which are largely names you’ve not heard of). Though the smaller you get, the more hit and miss things are, the ones that are ‘hits’ are really, really big hits.

The grid below shows the highlights of those numbers, starting with the biggest names in the group, and working its way down to the smallest. For more fundamental details, click here to find our expanded defense stock matrix.

The stocks highlighted in green are our picks of the litter, so to speak. Those seven names not only stand above their peers of all sizes in terms of current and future results, but they also stand to benefit the most from yet-another big military budget for next year.

We’ll follow up on this big trend, and suggest specific trades, when merited.

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Disclosure: No positions