Defense Budget Expands: 3 Stock Choices - Analyst Blog

President Obama's budget proposals have come as good news to the defense industry. Not only is spending projected to increase, weapons acquisitions will go up. Additionally, there is no prospect of any large weapons program being cancelled. The increase in procurement despite a reduction in conflict zones seems to be the signature feature of the budget.

New Priorities

Despite the resolution of older conflicts, new issues have come into focus. These include ISIS, the crisis in Ukraine, and the Ebola outbreak in West Africa. All of this will require a response from the U.S. military and have led to an increase in proposals for the research and procurement budgets which add up to around $180 billion. These budgets have been raised and the decision bodes well for companies who have contracts extending over several years.

The new proposal is for a budget of $585 billion. Of this, $534.3 billion will be allocated for the base budget and $50.9 billion will be utilized for overseas contingency operations. The base budget is $25 billion higher than what received Congress's approval last year. However, it is also $36 billion more than what sequestration would allow.

Leaner, Smarter Force Structure

Over the next five years, the Department of Defense is looking to turn the armed forces into a smaller yet nimble force which relies on technological advancements. The budget proposals plan to reduce the size of the army to a force of 475,000 soldiers on active duty. In case sequestration causes further spending cuts, this figure may go down to 420,000. An earlier proposal had envisaged a reduction to 490,000, an outcome of the end of two major wars in Iraq and Afghanistan.

At the same time, higher investment in cyber defense and cutting edge defense systems has been planned. The budget has been formulated around these new priorities. In addition, there is emphasis on the "pivot to Asia" approach which seeks to have more U.S. assets in the Asia-Pacific region.

Acquisitions Take Center Stage

Among key decisions which have been taken is an increase in purchases of the F-35 Joint Strike Fighters, manufactured by Lockheed Martin Corp. ( LMT ). The company will receive $10.6 billion for the 57 jets to be supplied in 2016, up from the 38 planned for this year.

Lockheed will also benefit from an increase in expenditure on the C-130J Hercules cargo aircraft. Meanwhile, The Boeing Company ( BA ) will receive $3.4 billion for 16 P-8 Poseidon maritime patrol aircraft and another $3 billion for development of the proposed KC-46 aerial refueling tanker.

The most significant procurement decision to be taken this year is who to award the contract for the new Long Range Strike Bomber (LRSB) for the Air Force. Boeing and Lockheed Martin will combine to compete with Northrop Grumman Corp. ( NOC ) on a contract for the LRSB, possibly worth $40 billion. The budget proposal allocates $1.2 billion toward this project and the contract for developing this fighter is likely to be awarded by the end of 2015.

Our Choices

Aerospace companies stand to gain substantially from this year's defense budget. Below we present three stocks which will gain from these trends, each of which also has a good Zacks Rank.

Spirit AeroSystems Holdings, Inc. ( SPR ) is a non-original equipment manufacturer. The company is a designer and manufacturer of commercial plane assemblies and components across the world. Spirit AeroSystems has three operating segments, namely Wing Systems, Fuselage Systems and Propulsion Systems. The company offers products and services to key defense contractors as well as the U.S. government.

Spirit AeroSystems holds a Zacks Rank #1 (Strong Buy) and has expected earnings growth of 46.6%. The forward price-to-earnings ratio (P/E) for the current financial year (F1) is 13.01.

Curtiss-Wright Corp. ( CW ) produces precision components for the aerospace, industrial and marine companies. Curtiss-Wright has three operating segments. These are Surface Technologies, Flow Control and Controls. The Control segment serves the defense and aerospace sectors among others. The Flow control segment serves the naval defense sector among others.

Apart from a Zacks Rank #2 (Buy), Curtiss-Wright has expected earnings growth of 15.9%. It has a P/E (F1) of 16.99x.

Rockwell Collins Inc. ( COL ) designs, manufactures and supports software and hardware solutions for aircraft communication, navigation, signals intelligence and weapons systems as well as surveillance systems for the government, military and commercial applications.

Rockwell Collins holds a Zacks Rank #2 (Buy) and has expected earnings growth of 16%. It has a P/E (F1) of 16.92x.

The increase in procurement envisaged in the new defense budget is likely to provide a fillip to the defense industry. Contracts for the development of new equipment are also likely to be awarded this year. This is why adding these stocks to your portfolio would make for a prudent investment choice.

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NORTHROP GRUMMN (NOC): Free Stock Analysis Report

BOEING CO (BA): Free Stock Analysis Report

ROCKWELL COLLIN (COL): Free Stock Analysis Report

SPIRIT AEROSYS (SPR): Free Stock Analysis Report

LOCKHEED MARTIN (LMT): Free Stock Analysis Report

CURTISS WRIGHT (CW): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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