Why Defense Stocks Are Doing Well
By: Jane Wells | CNBC Reporter
Looking at the performance of defense stocks, you wouldn't realize the nation was in a budget crisis and the Pentagon has a financial target on its back. Defense shares have continued to be positive going into earnings season (Boeing aside due to 787 problems), even though most analysts believe earnings will be lower than a year ago.
Specifically, Lockheed Martin, Northrop Grumman, and Raytheon have strongly outperformed the broader market over the last year.
Why are there so many bulls for bullets and bombs?
In the short term, orders have remained strong for most of these firms, and the threat of the "fiscal cliff" may have had the opposite effect than anticipated.
"On the contrary, I think there's an opportunity for bookings rates to actually outperform expectations," Citi's Jason Gursky said. "That's going to be because the DOD was trying to get as many contracts done in the fourth quarter in anticipation of sequester potentially being implemented in early January."
(Read More: Three Defense Industry Predictions for 2013.)
Gursky said international demand has also been strong, "which should have positive implications particularly for Lockheed Martin and Raytheon with missile defense systems sales in the Middle East." International sales tend to have higher margins.
Jefferies analyst Howard Rubel expects the fourth quarter of 2012 to mark "a slight deceleration in growth." However, he added, "We could see growth rates level off this quarter and accelerate in the second half."
Two of the major defense companies have brand new CEOs, and both are women: Marilyn Hewson at Lockheed and Phebe Novakovic at General Dynamics. (Read More: Is the Defense Industry Becoming a Girls' Club?)
Lockheed's Hewson has said the F-35 Joint Strike Fighter is a personal priority for her, and much of the earnings call may focus on a Pentagon report signaling problems with the expensive program. The report claims the jet missed several test objectives in 2012, and reports claim engineers are concerned the fuel tank on one variant, the F-35B, could explode if struck by lightning. (Read More: Lockheed Struggling to Deliver F-35 Jet.)
Still, Goldman Sachs has high expectations for Lockheed Martin, predicting the company will give higher than anticipated guidance for 2013. It's also estimating that fourth quarter EPS will come in at $1.96/share, 18 cents higher than consensus.
What about the threat of sequestration and the extra $500 billion in cuts which could hit the Pentagon unless a deficit solution is reached by March 1? Analysts said sequestration would only affect future contracts, unless the government wants to pay the penalty of breaking existing agreements. That puts the real cause for concern regarding earnings at least a year out.
"Investors look, I think, primarily at two things with defense companies right now," said Citi's Jason Gursky. "One is cash deployment. and we want to make sure that we're targeting that 8 to 12 percent cash deployment through dividends and share repurchases. And then bookings, because bookings are going to tell us what future revenue streams are going to look like ... I think on both of those fronts we've got really nice things to say about both Raytheon and Lockheed at this point."
(Read More: The 10 Biggest U.S. Government Contractors.)
—By CNBC's Jane Wells; Follow her on Twitter: @janewells
