With many of the budget issues conceivably coming to an end
and the global economy finally strengthening, the defense biggies
are expected to see stability in 2014. The $1.1 trillion Omnibus
spending measure President Obama signed into law recently was a
big relief for the Pentagon. The bill provides Pentagon with
nearly $93 billion to buy weapons and another $63 billion for
research and development.
Again, the latest improvement in the U.S. benchmarks with the
U.S. Federal Reserve's confirmation of continued stimulus cut
brings some respite to the defense sector. The Fed said it will
pare its bond-buying agenda by $10 billion for the second
straight month that is expected to trigger optimism with a
stronger greenback and softer import costs.
The Aerospace & Defense sector posted a stellar performance
in 2013, braving issues like sequestration, budget cuts and
cancellation of big-ticket programs. Many sector participants
have boosted margins through cost-cutting initiatives, while
others have beefed up international sales and focused on
high-growth businesses like commercial aircraft that is
independent of government spending.
Having said that, the defense sector will still continue to face
headwinds as Pentagon's spending moderates from historical
levels. The preeminent defense stocks will however keep their
momentum intact by taking good care of their shareholders for
years to come.
Three Top Players to Bet On
If given to choose the top three defense stocks, we would suggest
Lockheed Martin Corp.
Northrop Grumman Corp.
Alliant Techsystems Inc
Pentagon's foremost contractor Lockheed Martin forecasts higher
earnings for 2014 after registering charges related to U.S.
defense budget cuts and workforce reduction in the final quarter
of 2013. Despite the uncertainties, the company has been able to
generate $15.4 billion in orders in the quarter. Foreign orders
accounted for 23% of the total orders received and 17% of sales
in 2013. This year foreign sales are expected to rise to just
lower than 20% of total sales.
Lockheed Martin's pricey F-35 program emerged largely unhurt in
2013. The fighter jet is expected to gain significant traction in
2014 and 2015. The Omnibus bill backed 68 of the fighter jets
over the next two years and also earmarked $333.5 million for the
Air Force's Combat Rescue Helicopter program. The program calls
for Lockheed Martin to build 112 new search and rescue
helicopters under a joint venture with Sikorsky.
With a $52.17 billion market cap, this Zacks Ranked #2 (Buy)
stock trades at 15.4x forward earnings and has a
price-to-earnings growth (PEG) ratio of 1.89, which is in line
with most other defense stocks. Its current dividend yield is the
highest among the top six defense players at 3.27%.
Based on its strong operational performance, analysts expect a
solid long-term earnings growth rate of 8.17%. Along with a very
attractive price-to-book (P/B) multiple of 10.6 (versus the peer
group average of 3.44), Lockheed Martin has a return on equity
(ROE) of 186.8% as against its peer group average of 19.4%. The
company has registered an 11.4% share price appreciation so far
ALLIANT TECHSYS (ATK): Free Stock Analysis
LOCKHEED MARTIN (LMT): Free Stock Analysis
NORTHROP GRUMMN (NOC): Free Stock Analysis
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Although the U.S. Department of Defense (DoD) may be less
enthusiastic about big ticket programs these days, Northrop
Grumman with support from the Congress has successfully warded
off efforts from the Air Force to retire the fleet of Global
Hawks. Again, the company stands to gain from the lawmakers'
assurance of the F-35 as it manufactures the AN/APG-81 Radar for
the fighter jet. Its aggressive cost-cutting initiatives should
pave the way for the achievement of long-term expected earnings
growth of 7.71%.
The stock has a PEG ratio of 1.74 and currently sports a Zacks
Rank #1 (Strong Buy). It trades at 13.44x forward earnings
estimate, a 14.5% discount to the peer group average of 15.7x. It
has a current dividend yield of 2.03% and its share price
escalated 6.0% since the start of 2014.
This Zacks Rank #1 (Strong Buy) company delivered robust third
quarter fiscal 2014 results driven by its Sporting business. The
company witnessed a share price appreciation of around 9.4% so
far this year. Alliant Techsystems also boosted its fiscal 2014
top- and bottom-line expectation based on solid fundamentals. The
long-term earnings growth for Alliant Techsystems is expected to
be more than 12%.
Shares of Alliant are going for about 13.3x the estimate for
2014, a discount to the peer group average of 13.5x.
The defense pros have been awarded a steady stream of contracts
from the Pentagon lately, much to their relief. These companies
are also on the lookout for more international contracts,
commonly referred to as foreign military sales, to keep their top
Add to this the growing commercial opportunities, thanks to an
improving global economy, aging commercial aircraft at most
airlines and an inevitable rise in commercial aircraft orders.
Defense spending is expected to rise in many foreign countries
while technological innovation and acquisition deals strengthen
these defense players and lift the overall sector.