By
TopYields
:
The U.S. defense budget (see chart below) will shrink in the
coming years, with some $487 billion in cuts already planned for
the next decade. According to the Pentagon:
U.S. defense spending in 2012 will total $612 billion, down
slightly from 2010's $691-billion peak
due to lower spending on the Iraqi and Afghan wars. The Pentagon
budget, excluding the cost of these wars, is $531 billion in 2012.
In the current fiscal year, which started on October 1, that core
budget will slip to $525 billion. The much-feared sequestration, a
process of automatic across-the-board budget cuts, scheduled for
January 2, 2013, would trim about 11% from the Pentagon's spending,
according to estimates cited by Reuters.
(click to enlarge)
The lower government spending spells trouble for a number of
U.S. defense contractors. While some contractors have started to
lay off workers and idle facilities, others are bracing for the
impact, alerting it could be devastating. Still, despite all the
gloom and doom in the sector, many defense-related companies are
likely to weather the storm and to reposition themselves in line
with the new realities. Notwithstanding the river of red ink
splashing over the defense budgets, a number of defense-related
stocks represent good value and income plays. In fact, most of the
largest players in the sector and related industries are
high-quality stocks, showing sustainable earnings power and
stability of dividend payouts and growth over long-term
horizons.
Let's take a look at
Lockheed Martin
(
LMT
). This high-yielder boasts a dividend yield of 4.9%, after
increasing its dividend by 15% in late September. The stock's
payout ratio is now 47%. Over the past five years, Lockheed Martin
boosted its dividend at an average rate of nearly 23.3% per year.
Despite the budgetary cuts planned for the next five years, the
company's EPS is forecast to accelerate from the average rate of
6.3% per year to 7.2% per year for the next five years. The stock
has a forward P/E of 11.9x, below that of the aerospace industry at
14.1x, but above the defense industry's at 10.6x. The stock, which
has an exceptionally high return on equity of 102%, is also popular
among hedge fund investors, with value investor Jean-Marie
Eveillard owning nearly $345 million in the stock.
Another company with a large share of revenues from the defense
sector that is expected to see faster EPS growth in the coming
years is conglomerate
United Technologies
(
UTX
). United Technologies is forecast to boost its average annual rate
of EPS growth to 11.5% for the next five years from 8.2% per year
realized, on average, over the past five years. The company is a
good dividend growth stock, posting average dividend growth of 12%
per year over the past half decade. The stock's forward P/E is
14.4x, trading at a small premium to the aerospace industry's ratio
but above that for the defense industry. Currently, the stock is
yielding 2.8% on a payout ratio of 45%. The stock has a ROE of 23%.
Among other things, the company produces aerospace products and
manufactures military and commercial helicopters, as well as
aircraft parts and services.
Other potential high-quality defense-related stocks paying
attractive dividends include
Raytheon
(
RTN
),
Northrop Grumman
(
NOC
) and
General Dynamics
(
GD
). All these stocks will see lower EPS growth, on average, over the
next five years. However, that growth will still be positive and
higher than the forecast rates of U.S. GDP growth. Raytheon is
currently yielding 3.6%, two percentage points more than the
10-year Treasury bond. The stock has a beta of 0.8, which implies
lower volatility than that for the broader market. Raytheon has
boosted its dividend at high rates, averaging about 14% per year
over the past five years. Given that its dividend payout ratio is
low at 35%, future dividend hikes are likely. The company's forward
P/E of 10.4x is about on par with that of the defense industry.
Raytheon is the world's sixth largest military contractor, which
makes high-tech missiles, advanced radar systems, defense
electronics and missile-defense systems.
Northrop Grumman is a maker of aircrafts, spacecrafts,
high-energy laser systems, intelligence and reconnaissance systems.
The stock is yielding 3.2% on a low payout ratio of 28%. Over the
past five years, the company boosted its dividend at an average
rate of 8.3%. The company was just awarded a $108-million contract
to update the Air Force's fleet of B-2 stealth bombers. Given the
company's low payout ratio and continued EPS growth, dividends are
likely to continue to grow in the future. Northrop Grumman has a
relatively low debt-to-equity ratio and a high free cash flow yield
of 12.4%. The stock has a forward P/E of 10.0x, slightly below that
of the defense industry. Value investor Jean-Marie Eveillard, who
owns $423 million in this stock, is also bullish about Northrop
Grumman
General Dynamics has raised dividends for straight 21 years. The
stock is currently yielding 3.1% on a low payout ratio of 30%. Its
yield is almost double that of the 10-year Treasury bond and 50%
higher than the yield on the S&P 500 index. General Dynamics is
not expected to see a notable drop in its EPS growth, so its future
dividend growth, amid a low payout ratio, is likely assured. For
the reference, the stock grew its dividends at an average rate of
12.7% per year over the past five years. The company has just
received an order for the purchase of two-channel digital radios
for infantry rucksacks and vehicles worth an estimated $250
million. As regards its valuation, the stock has a forward P/E of
9.1x, below the defense industry's ratio. Like its peer Northrop
Grumman, the stock has a low debt-to-equity ratio and a high free
cash flow yield of 9.3%. It is worth noting that this stock has a
seal of approval from legendary investor Warren Buffett.
The overall impact from the expected defense budget cuts on the
aforementioned stocks is likely limited. However, the outlook for
defense stocks could improve in the unlikely case the Republican
Presidential candidate, Mitt Romney, wins the U.S. Presidency.
Despite his intentions to boost military spending, Romney would
quickly face the reality of widening budget deficits and the
pressure from the fiscal conservatives in favor of austerity.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
See also
5 Safe Companies That Have Raised Their Dividends
For 30 Years
on seekingalpha.com