The intense focus on sequestration is understandable because the budget cuts will reshape the world of DOD contracts. Nearly $48 billion will be cut from 2013 military spending and a similar amount each year going forward for the next decade. No wonder most investors are keeping far away from defense stocks. However, this obsession over the sequester cuts is creating some hidden opportunities for careful investors. By avoiding the military sector, investors have underpriced a few companies. LMI Aerospace Inc. (NASDAQ; LMIA) appears to be one of these companies.
LMI Aerospace fabricates aluminum components for military and commercial aircraft. Since nearly going broke in the market crash of 2008, LMI has been able to deliver consistent revenues and profits. The company currently has a healthy 7.22 percent profit margin. To continue expanding its operations, LMI purchased a competing company, Valeant Aerostructures, this past January. By combining the product lines of the two companies, LMI expects to significantly expand its portfolio of products which should lead to a decent jump in revenue.
In another positive move, LMI also secured a large line of credit through Regal-Beloit Corporation (NYSE: RBC) and Wells Fargo & Company (NYSE: WFC). While LMI initially wanted to have a $75 million five-year line of credit, the banks decided to up this limit to $125 million. This increased liquidity helped with the purchase of Valeant. While LMI initially expected to operate at an initial loss because of this purchase, it now expects to grow its 2013 revenues. Analysts expect these two moves will have a strong positive impact on LMI's share price and have set an average price target at $27. Considering that LMI is currently trading at about $22, investors are leaving nearly a 22 percent gain on the table as they wait for the sequester cuts to go through. This could be a great chance to get in before the crowd.
Of course, any investment in the defense sector today is a speculative move. No one knows exactly how this bill will end up. If LMI loses some of its key contracts, this damage will offset the gains of its recent moves. This isn't expected, but it could happen. Should LMI hit a rough patch, it would be in a tough financial spot. The company spent nearly all its cash on the Valeant acquisition. However, the new line of credit gives it some liquidity to work with as it sorts out the next few months.
While the sequester cuts are certainly going to be a challenge, LMI has shown that it's capable of surviving tough situations. The upside benefit of its recent moves mean this stock has more breathing room to deal with the sequester cuts than competing companies. If you are willing to jump in the defense sector now while everyone else waits on the sideline, you have the chance for some potentially lucrative deals. LMI Aerospace seems like a great place to start.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.