Buy any weakness on defense stocks as Biden won't be bad for the industry, Citi says

Published Thu, Jan 14 202110:52 AM ESTUpdated Thu, Jan 14 202112:28 PM EST

Investor fears that a Democratic Congress and White House could lead to significant defense budget cuts are overblown and offer an opportunity to buy beaten-down names, according to Citi. Analyst Jonathan Raviv told clients that recent underperformance in stocks like Mercury Systems and electronic weapons supplier L3Harris should be bought given the composition of the Senate. "We're buyers of any weakness since we don't think [President-elect Joe] Biden is actually that bad for defense," Raviv told clients last week. "He said in September that he doesn't foresee major budget reductions. And his national security nominees appear as if they'll focus on a smaller, more technologically-advanced military to face rising challenges." Citi's research team noted that the Republican party, the home of stringent budget hawks during the 2008 financial crisis, does not seem as laser-focused on cutting spending during the Covid-19 crisis. "It wasn't so much Obama the Democrat who cut defense; it was the deficit-obsessed Tea Party that put the US on the path to sequester by threatening a debt default," the analyst wrote. "So, budgets don't happen in a vacuum without regard for other political dynamics." All of that is likely to boost business outlook at the handful of industrials businesses that supply the U.S. military with arms and technology. The optimism was on full display during Northrop Grumman's most-recent earnings call. The company, one of the globe's largest weapons manufacturers and maker of the B-21 Raider, said in October that it was not worried about security spending in the near term. "We expect to see continued, strong, bipartisan support for national security in the future as indicated by the $740 billion targeted for FY2021 appropriations," CEO Kathy Warden said on Oct. 22. "We continue to believe that bipartisan support for defense spending will endure and that our portfolio is well-aligned to support our National Defense Strategy," Warden added at the time. Congress handed President Donald Trump the first veto override of his tenure earlier this month when both the Senate and the House passed the $740 billion National Defense Authorization Act with more than two-thirds majorities. The bill, a 60-year tradition, authorizes hazard-pay raises for troops and secures funds for aircraft, ships, nuclear weapons and other national -security equipment. Anticipated outperformance among defense stocks may come as welcome relief since both the broad industrials sector and the aerospace and defense industry have underperformed the S & P 500 over the last 12 months. Collectively, aerospace and defense stocks in the S & P 500 have declined 22.5% over the last year. That group includes Raytheon , Lockheed Martin and General Dynamics . The two stocks Raviv highlighted, L3Harris and Mercury Systems, have posted a loss of 12.3% and a gain of 8.6%, respectively, over the same period.

A file photo from September 2007 showing then-Senator Joseph Biden speaking to U.S. Marines during a visit to Ramadi, Iraq.

John Moore | Getty Images

Investor fears that a Democratic Congress and White House could lead to significant defense budget cuts are overblown and offer an opportunity to buy beaten-down names, according to Citi.

Analyst Jonathan Raviv told clients that recent underperformance in stocks like Mercury Systems and electronic weapons supplier L3Harris should be bought given the composition of the Senate.

"We're buyers of any weakness since we don't think [President-elect Joe] Biden is actually that bad for defense," Raviv told clients last week. "He said in September that he doesn't foresee major budget reductions. And his national security nominees appear as if they'll focus on a smaller, more technologically-advanced military to face rising challenges."