With North Korea In The Crosshairs Let's Analyze The Defense Industry

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Includes: AAXN, AIR, AJRD, AOBC, ATRO, AVAV, BA, BRK.A, BRK.B, BWXT, CAE, COL, CVU, DCO, DIA, ERJ, ESL, ESLT, GD, HEI, HII, HXL, ISSC, KAMN, KLXI, LLL, LMT, NOC, NPK, OA, RADA, RGR, RTN, SPR, TATT, TDG, TGI, TXT, UTX, WWD
by: Mycroft Friedrich
Summary

Discusses how North Korea's missile launches are causing great concern globally and forcing many world leaders to ramp up their defense spending.

Presents a list of companies in the Aerospace and Defense industry, which may very well benefit from the coming crisis.

Will use our Algorithm to analyze each company using Quantitative Charting and allow the reader to see which companies come out best and which should be avoided.

On December 11, 2017 Seeking Alpha's News Editor Yoel Minkoff wrote the following news article :

N.Korea: Blockade would be 'declaration of war'

Dec. 11, 2017 2:54 AM ET|By: Yoel Minkoff, SA News Editor

"North Korea said Sunday that a maritime blockade would be a declaration of war, in reference to one of the new sanctions the United States mentioned it could impose on Pyongyang.

The comments came as the U.S., South Korea and Japan launched rocket tracking drills today aimed at improving detection and monitoring of the isolated regime's ballistic missile tests."

Ever since North Korea started launching missiles with greater frequency, World leaders seem to be getting more nervous with every new launch. Obviously North Korea's neighbors are not sitting by and waiting, but are ramping up their own defense forces, which should only escalate matters. The scary part is that past rhetoric, has now been converted over to reality and we just need one slip up by North Korea (where one of its test rockets actually hits Japan) and the world could descend into a major Korean conflict. This could lead to 100's of thousands of lives (if not millions) lost or injured. My personal hope is that everything will be solved peacefully, but I am not very optimistic.

Nevertheless all this saber rattling should do wonders for the Aerospace and Defense Industry and I thought it would be interesting to see how our Investment Algorithm Friedrich would analyze the companies that make up that industry. This article will use a new method of charting stocks that is not Technical Analysis, but instead is called "Quantitative Analysis Charting".

The main metric used in creating our quantitative charts is free cash flow, which makes up a great majority of our investing system. What I am trying to do is analyze each company's Main Street performance and then compare it to Wall Street. Here is a back test I did of the Dow Jones Industrial Average (DIA) from 1950-2009 (60 years) where I back tested what an investor would have seen using a simple Free Cash Flow ratio. The ratio per share used is calculated so.

FCF/DSO = [((Net Income + Depreciation + Amortization) - Capital Spending)/Diluted Shares Outstanding]

Obviously, from the results of my backtest I was able to establish a firm foundation to work off of and through a series of original ratios I was able to amplify the power of free cash flow in my analysis of Main Street. Using GAAP (Generally Accepted Accounting Principles) vs. Pro-Forma, which is commonly used by most analysts on Wall Street, I am able to see how each company is actually performing on Main Street. That of course is a strength, but if there is a weakness in our system (or maybe a blessing in disguise), it is that it tends to be ultra-conservative and towards the end of bull markets comes up with only a handful of stocks to buy. I have addressed this weakness by introducing our charting system, in order to assist those investors who are more aggressive than I may be and want to buy and hold or stay as fully invested as they can. I did so by setting up what looks like a technical analysis chart, but is actually a quantitative analysis chart.

This new chart format starts out with the Wall Street price and compares it to three Main Street price (our estimated value) final results for each stock under analysis. Thus I give every user the ability to see at a glance our Algorithm's buy, sell and hold price for every stock under analysis, so each user can know where they stand at all times. Through the use of automation we are also able to analyze entire indices, ETFs and Mutual Funds, which also gives us the big picture of how overbought or oversold such investments might be at any given time. All I am doing in the end is telling you what Main Street is valuing each company at, similar to how a businessperson would do when valuing a company on Main Street. The Wall Street Price is simply the group opinion of what market participants are valuing each company (or the markets as a whole at any given point in time).

My idol is Warren Buffett (BRK.A)(BRK.B) and I have intensely studied his work for over 30 years and what I have learned, from all my studies, is that in the end Main Street is what really matters and if you get the numbers right on Main Street, then eventually Wall Street will come around and soon follow as:

"In the short run, the market is a voting machine but in the long run, it is a weighing machine." ~ Benjamin Graham

The quantitative charts that you will see for each company analyzed are broken up into three categories:

1) Oversold = Bargain

2) Overbought = Sell

3) Hold

Since those are pretty much self explanatory, I will move on and (before displaying a quantitative chart for each company) here are the stocks that we cover for our SA Marketplace service in the Aerospace and Defense Industry.

Company Name Ticker Market Cap (Millions)
AAR Corp. AIR $1,408
Aerojet Rocketdyne Holdings, Inc. AJRD $2,250
AeroVironment, Inc. AVAV $1,091
American Outdoor Brands Corporation AOBC $761
Astronics Corporation ATRO $1,163
Axon Enterprise, Inc. AAXN $1,276
BWX Technologies, Inc. BWXT $6,095
CAE Inc. CAE $4,750
CPI Aerostructures, Inc. CVU $79
Ducommun Incorporated DCO $314
Elbit Systems Ltd. ESLT $6,005
Embraer S.A. ERJ $3,563
Esterline Technologies Corporation ESL $2,132
General Dynamics Corporation GD $61,866
HEICO Corporation HEI $6,914
Hexcel Corporation HXL $5,564
Huntington Ingalls Industries, Inc. HII $10,921
Innovative Solutions and Support, Inc. ISSC $48
Kaman Corporation KAMN $1,629
KLX Inc. KLXI $2,890
L3 Technologies, Inc. LLL $15,213
Lockheed Martin LMT $90,560
Moog Inc. MOG-A $2,998
National Presto Industries, Inc. NPK $710
Northrop Grumman Corporation NOC $52,039
Orbital ATK, Inc. OA $7,624
RADA Electronic Industries Ltd. RADA $94
Raytheon Company RTN $54,328
Rockwell Collins, Inc. COL $21,548
Spirit AeroSystems Holdings, Inc. SPR $9,655
Sturm, Ruger & Company, Inc. RGR $949
TAT Technologies, Ltd. TATT $94
Textron Inc. TXT $14,525
The Boeing Company BA $160,150
TransDigm Group Incorporated TDG $15,541
Triumph Group, Inc. TGI $1,462
United Technologies Corporation UTX $93,326
Woodward, Inc. WWD $4,642

With the introduction out of the way here are our Quantitative Charts for each company. Please click on each chart to expand for a better view.

AAR Corp. (AIR)

Very attractively priced with a lot of room to run before hitting its Overbought price.

Aerojet Rocketdyne Holdings, Inc. (AJRD)

Very little consistency as a result of management taking many one time events. Looks like a pro-forma machine.

AeroVironment, Inc. (AVAV)

Way Overbought.

American Outdoor Brands Corporation (AOBC)

Operates in oversold territory but recent activity shows that its results on Main Street are deteriorating.

Astronics Corporation (ATRO)

Good company on Main Street that is just Overbought.

Axon Enterprise, Inc. (AAXN)

Deteriorating numbers on Main Street and way Overbought.

BWX Technologies, Inc. (BWXT)

Average company with many one time events. Overbought according to our Algorithm.

CAE Inc. (CAE)

Had major one time events that skewed the chart in 2009-2010, thus you can't really see it's chart results, so here is the corresponding Datafile. Clearly, it is overbought.

CPI Aerostructures, Inc. (CVU)

Multiple one time events with no consistency, but it's trailing twelve months numbers look decent and it is attractively priced.

Ducommun Incorporated (DCO)

Another Pro-forma operator, seems like most of the industry lives off of pro-forma. Result is Overbought.

Elbit Systems Ltd. (ESLT)

Good Main Street operations but Wall Street already noticed that and shot it to an Overbought level.

Embraer S.A. (ERJ)

Has been Overbought for years and Friedrich has been right in telling our clients to avoid it.

Esterline Technologies Corporation (ESL)

Solid company and out of favor with Wall Street. A hold according to our Friedrich Algorithm.

General Dynamics Corporation (GD)

Solid company with strong trailing twelve months numbers TTM, making it Oversold.

HEICO Corporation (HEI)

Great company on Main Street, but unfortunately it is Overbought.

Hexcel Corporation (HXL)

Way Overbought relative to its Main Street free cash flow generation.

Huntington Ingalls Industries, Inc. (HII)

Great company but a weak hold according to Friedrich.

Innovative Solutions and Support, Inc. (ISSC)

Ugly chart for this Pro-forma operator, zero consistency though trailing twelve month TTM numbers look good.

Kaman Corporation (KAMN)

Great solid performer on Main Street, but unfortunately Wall Street has bid it up to an Overbought level.

KLX Inc. (KLXI)

Zero consistency on Main Street and Overbought.

L3 Technologies, Inc. (LLL)

Average company on Main Street, but loved on Wall Street and which brought it to Overbought level.

Lockheed Martin (LMT)

Super Company and monster of the industry. We bought it for our all our model portfolios and happy that we did so. Strong Hold and I wrote about it here on SA this past April .

Moog Inc. (NYSE:MOG.A)

Strong company on Main Street and gets a Weak Hold rating from our Algorithm.

National Presto Industries, Inc. (NPK)

Very attractive on Main Street and Wall Street, Oversold!!

Northrop Grumman Corporation (NOC)

Super Warrior on Main Street, but unfortunately Overbought.

Orbital ATK, Inc. (OA)

Average company on Main Street and Overbought.

RADA Electronic Industries Ltd. (RADA)

Dog with fleas on Main Street and Short rated by Friedrich.

Raytheon Company (RTN)

Great company but unfortunately Overbought.

Rockwell Collins, Inc. (COL)

Strong company but it looks like United Technologies (UTX) maybe way overpaying for it.

Spirit AeroSystems Holdings, Inc. (SPR)

Couple of good years for the company on Main Street but Wall Street had already shot it to Overbought.

Sturm, Ruger & Company, Inc. (RGR)

Play of the Gun lobby vs. Gun protest lobby. Clearly a value play.

TAT Technologies, Ltd. (TATT)

Clearly a sinking ship on Main Street and Short candidate according to our Algorithm Friedrich.

Textron Inc. (TXT)

Strong company on Main Street with great products, but unfortunately Overbought.

The Boeing Company (BA)

Premier player and top holding in our Friedrich Dividend Portfolio. Still long way to run. Our analyst, Mark Bern, CFA, wrote about it here.

TransDigm Group Incorporated (TDG)

Solid player on Main Street but Overbought on Wall Street.

Triumph Group, Inc. (TGI)

#1 ranked short in our Friedrich Short Portfolio. Train Wreck coming according to Friedrich.

United Technologies Corporation (UTX)

Great company and major part of our Friedrich Model portfolios.

Woodward, Inc. (WWD)

Doing better on Main Street but Wall Street is way too optimistic. Overbought.

As you can see from the results above, that the Aerospace and Defense Industry is no bargain right now and going forward Friedrich is recommending that those who want to invest in it, should concentrate on the major players like Boeing, Lockheed Martin and United Technologies. Market share plays a major role as those who are in good with the Pentagon do very well and everyone else is fighting for the scraps. If there is a war with North Korea the F-35's as well as other aircraft will play a major role. This clearly is a wake up call for Japan, and even Germany, to get going and beef up militarily as they are within range of North Korea's missiles. The world is going to beef up on defense and companies like Lockheed Martin are sitting in the catbird seat.

In addition to our Friedrich algorithm, we also rely on a tool that I found to be very useful in verifying our work. The Forensic Accounting Stock Tracker (FAST Model) helps identify companies that may be resorting to more financial tricks to make analyst estimates. The model helps pinpoint where management might be aggressive with revenue recognition, cash flows, the balance sheet, and also takes into account valuation and other metrics. Here is the FAST Models result for Lockheed Martin:

@DelvecchioJd

In conclusion, it is my belief that free cash flow analysis is the ultimate tool when analyzing companies, and my hope is that you may add the ratio to your own investor tool box in order to help you in your own due diligence. If you have any questions, please feel free to ask them in the comment section below, and don't forget to hit the "Follow" button next to our username at the top of this article, so you won't miss similar article in the future.

Disclosure: I am/we are long LMT, BA, UTX. 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.

Additional disclosure: DISCLAIMER: This analysis is not advice to buy or sell this or any stock; it is just pointing out an objective observation of unique patterns that developed from our research. Factual material is obtained from sources believed to be reliable, but the poster is not responsible for any errors or omissions, or for the results of actions taken based on information contained herein. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.