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Pentagon 2017 Budget Plan Puts Defense Stocks in Focus

U.S. Defense Secretary Ash Carter unveiled the Pentagon's fiscal year 2017 (FY 2017) budget request that is intended to reshape spending priorities taking into account new and evolving challenges.

Carter said that President Obama's fiscal year 2017 budget will request $582.7 billion in funding for the Pentagon, including $71.4 billion for R&D, $7.5 billion to fight the Islamic State, $8.1 billion for submarines (with over $40 billion in the next five years), and $1.8 billion on munitions. The White House plans to release the President's full budget proposal for fiscal 2017, beginning Oct 1, on Feb 9.

The budget proposal mainly addressed five key challenges, namely, the threat of Russian aggression in Europe as well as that of China in the Asia-Pacific, North Korea to the U.S. and its Pacific allies, Iran's influence against allies in the Gulf, and the ongoing fight against the Islamic State.

While speaking to the Economic Club of Washington, Carter said, "Today's security environment is dramatically different than the one we've been engaged with for the last 25 years and it requires new ways of thinking and new ways of acting."

Among the priorities, the budget will seek a major boost in funding for the fight against Islamic State as part of its FY 2017 defense budget request. This signifies a potential stepping up of U.S. military efforts. The $7.5 billion request for the fight against Islamic State is up about 50% from the FY 2016 allocation.

Carter also said that the Pentagon intends to propose $3.4 billion to boost military training and exercises for reassuring European countries. This is almost a four-fold increase from last year's $789 million that will likely help the U.S. to reinforce its military stance in Europe in view of Russia's ominous moves in Eastern Europe since the annexation of Crimea in Mar 2014 and the ensuing war in eastern Ukraine.

The proposed budget will also seek to enhance spending in several key areas, including cybersecurity, electronic warfare and increased security for crucial U.S. satellites.

The gloomy days for the defense sector seem to be a thing of the past. As far as the budget is concerned, the defense majors are expected to receive a vital tailwind. In this positive climate for defense spending, it makes sense to pick up aerospace and defense stocks that are likely to benefit from the situation. We would suggest the following names:

Lockheed Martin Corp.LMT

The Pentagon's prime contractor is the maker of the defense department's costliest program, the F-35 fighter jet. Apart from F-35 fighter jets, Carter in its next year's budget proposal underscores the need for spending nearly $1 billion over the next five years to buy new Long Range Anti Ship Missiles built by Lockheed Martin.

Lockheed Martin ended 2015 with nearly $100 billion of backlog. The company currently holds a Zacks Rank #3 (Hold) and has an expected long-term earnings growth rate of 6.25%. The stock has a P/E (F1) of 17.86x, compared to the industry average of 40.70.

Northrop Grumman Corp.NOC

Carter's budget emphasizes the need for a new Air Force Long Range Strike Bomber (LRS-B) awarded in Oct 2015 to Northrop Grumman. The Air Force plans to buy 80 to 100 of the new airplanes, and the contract could go up to $50 billion to $80 billion.

Northrop Grumman, the developer of the Air Force's current bomber, the B-2, beat out the Boeing BA -Lockheed Martin team for the right to build the next generation of long-range aircraft. Currently, the U.S. Air Force has asked Northrop Grumman to stop work on the LRS-B contract, after the company's rivals, Boeing and Lockheed Martin, filed protests against the selection process.

He also aims to replace a fleet of nuclear-armed intercontinental ballistic missiles. An important part of Northrop Grumman's history lies in the nation's intercontinental ballistic missile program.

Northrop Grumman currently holds a Zacks Rank #3 and has an expected long-term earnings growth rate of 7.49%. The stock has a P/E (F1) of 17.76x, compared to the industry average of 40.70.

Huntington Ingalls Industries, Inc.HII

One of the prime beneficiaries of this new spending proposal will be Huntington Ingalls. For more than 100 years, this company has been building ships, aircraft carriers and submarines for the U.S. Navy at their shipyards in Virginia and Mississippi. The new plan emphasizes the need to replace the Ohio-class submarines that carry nuclear weapons.

Apart from Huntington Ingalls, General Dynamics Corp. GD owns shipyards and have the resources required to meet the growing need for naval properties. Although General Dynamics has a large market cap compared to Huntington Ingalls, we prefer the latter as it is more of a pure-play in this category, focusing only on naval military needs.

Huntington Ingalls carries a Zacks Rank #3 and has an expected long-term earnings growth rate of 11.15%. The stock has a P/E (F1) of 13.32x, compared to the industry average of 40.70.

Raytheon Co.RTN

The Pentagon intends to invest $2 billion over the next five years to acquire more of Raytheon's Tomahawk missiles and upgrade their capabilities. This would bring the U.S. inventory of the missiles to more than 4,000.

Raytheon carries a Zacks Rank #3 and has an expected long-term earnings growth rate of 6.76%. The stock has a P/E (F1) of 17.24x.

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NORTHROP GRUMMN (NOC): Free Stock Analysis Report

BOEING CO (BA): Free Stock Analysis Report

GENL DYNAMICS (GD): Free Stock Analysis Report

LOCKHEED MARTIN (LMT): Free Stock Analysis Report

RAYTHEON CO (RTN): Free Stock Analysis Report

HUNTINGTON INGL (HII): 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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