Major defense stocks reach all-time highs as investors see weapons spending boost

Key Points
  • Lockheed Martin, Northrop Grumman and Boeing among big defense contractors hitting new highs.
  • Proposed national defense funding by Congress would be 5 percent above the Trump administration's fiscal 2018 plan.
  • Earnings season for big defense names starts next week with Lockheed, and some analysts see the industry as primed for accelerating revenue growth on easier comps.
The patriot missile is manufactured at Raytheon's Integrated Air Defense Center in Andover, Mass.
John Tlumacki | The Boston Globe | Getty Images

As the defense budget moves through Congress, shares of several major Pentagon contractors are setting all-time highs in intraday trade.

Defense companies such as Lockheed Martin and Northrop Grumman have been gaining amid chatter that the proposed defense funding will come in at 5 percent above the Trump administration's fiscal 2018 plan.

Some of the defense stocks in late-day trading Wednesday eased off earlier highs but still closed in positive territory.

Also driving optimism in the sector is the expectation for more foreign military sales. Wednesday's rally comes ahead of defense earnings season kicking off Tuesday with Lockheed's second-quarter results.

"For defense, we see accelerating revenue growth on easier comps and strong outlays growth (up 11 percent [in] Q2)," said UBS defense analyst David Strauss in a research note Wednesday. He also sees a chance of "upside to 2018 defense EPS expectations."

These robots are used by special forces around the world
These robots are used by special forces around the world

Also, continuing danger from a nuclear-armed North Korea and NATO concerns about Russia are seen as a positive for the defense industry, particularly missile defense system makers such as Lockheed and Raytheon.

Raytheon, maker of the Patriot missile defense system, set an all-time high in intraday trading Wednesday, along with Boeing, Rockwell Collins and United Technologies. On Tuesday, the State Department approved the sale of a $3.9 billion Patriot system to Romania.

The SPDR S&P Aerospace and Defense ETF also hit an intraday high Wednesday. It is up more than 13 percent since President Donald Trump took office, while the broader S&P 500 index is up just under 8 percent during the same period.

Jefferies analyst Howard Rubel said in an interview that investors look at North Korea "as a bit of an insurance policy. So if something untoward does happen, these [defense] stocks are more likely than not to see further funding."

On Wednesday, South Korea and the U.S. agreed to apply "maximum pressure" on Pyongyang to push the hermit regime to dialogue over its nuclear weapons and missile testing, according to a report from South Korea's Yonhap News Agency. It follows North Korea on July 4 test-firing what's believed to be an intercontinental ballistic.

In the Middle East, there's also continued tension from a Saudi Arabia-led rift with Qatar.

"The global tensions have shone a spotlight on a vast amount of deals that are not yet complete but are meaningful," said Rubel.

At the same time, he said there's also risk of a slowdown in weapon sales due to the Qatar situation.

Last month, Sen. Bob Corker, R-Tenn., chairman of the Senate Foreign Relations Committee, said he would halt arms sales to Persian Gulf states in response to the current Saudi-led tensions with Qatar. That means large arms sales planned to the Saudis and other members of the Gulf Cooperation Council could be blocked until the crisis is resolved.

In May, Trump announced a $110 billion arms deal with the Saudis as part of his trip to the kingdom. That same month the Trump administration approved a $2 billion arms sale to the United Arab Emirates.

"The secretary of State [Rex Tillerson] has to help resolve the dispute between the Persian Gulf council countries and Qatar," said Rubel. "Otherwise, [there's] the potential for there to be some slowdown in weapon sales. But I think the expectation is that it could be solved.

Back in Washington, the defense budget is moving through Congress and a House plan would include roughly a 5 percent increase above the White House's plan and about 10 percent above the fiscal 2017 levels.

On Wednesday, the White House issued its response to the bill and said it "contains many promising reforms" but criticized it for failing to authorize a new Base Realignment and Closure, or BRAC, round. The administration wants the BRAC to free up around $2 billion in annual money for other defense programs.

Rubel said in a note issued Wednesday that the latest budget plan emphasizes "missile defense, readiness and restocking munitions."

According to Rubel's research note, Pentagon contract awards over the next 24 months could reach approximately $100 billion when all programs are included. "There are a number of awards that are expected to be announced near or soon after the end of 2017," he said.

For readiness, there's a proposed increase for both the Stryker carrier vehicle and M1 tank, both from General Dynamics. Ammunition also gets more attention, which Rubel said in an interview could be meaningful for suppliers such as Orbital ATK as well as General Dynamics.

On the missile defense front, he said the budget includes "plus-ups for tactical missiles, which helps move Lockheed and Raytheon." Both companies also are seeing demand for their missile and radar systems from U.S. allies.

Rubel also said there's "meaningful plus-ups for the F-35," the fifth-generation stealth fighter manufactured by Lockheed.

On Friday, Lockheed was awarded a $5.6 billion contract that modifies the 11th batch of its F-35 aircraft and includes a total of 74 planes. The aircraft are for domestic and foreign military sales.

Finally, Rubel stressed that even with the proposed Pentagon budget things are still fluid and there's still the larger budget to deal with. Also he noted there's also limits imposed by the Budget Control Act, which has held down defense spending in recent years.

"We still need to have a fiscal year 2018 budget that in some ways complies with the Budget Control Act," he said. "And some of the things that the administration proposes on the domestic side are nonstarters and have to be revised.

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How to play defense stocks amid North Korea's missile test
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