In times of war, investors' thoughts naturally may turn to defense stocks.
Continuing wars in Ukraine and Israel and Gaza, along with various simmering geopolitical hotspots around the world, could mean increased revenues for U.S. defense contractors, enhancing the allure of stocks in the aerospace and defense category.
Though aerospace and defense funds understandably haven't done well in this year's faltering market, some individual stocks have posted substantial gains. And now that the overall market has started moving upward in recent weeks, this could be an advantageous time for investors to consider the category.
Government sales account for varying amounts of revenues received by aerospace/defense companies — from 100% down to 30% or less in some cases.
Diversified revenue creates a 'sweet spot'
As the label aerospace and defense implies, many such companies have civilian business from jetliner manufacturers and airlines, so the current boom in commercial aviation is a positive for them. This diversification currently puts them in a sweet spot. Â
Though U.S. defense spending on contractors has been pared back a bit over last couple years, some aerospace and defense firms continue to benefit from total contract spending that increased markedly in 2017-2020, from $373.5 billion to $448.9 billion, rising with the total defense budget.
U.S. support in what's turning out to be a long war in Ukraine will likely push overall contractor spending higher, benefitting aerospace and defense companies.
In this era of high-tech warfare, when strategic military engagement is more about digital systems and aerial weapons than boots on the ground, aerospace and defense companies are advantageously positioned. Lucrative products include fighter jets, helicopters, parts for them, avionics products, missile guidance system, drones and anti-drone technology and support services.
Lesser-known companies have key market positions
Publicly traded companies in this category with relatively low downside risk (based on various fundamental metrics) and good growth projections include some familiar names of large companies, including General Dynamics, Lockheed Martin and Northrup Grumman.
Yet, standing out from such behemoths are some lesser known and/or smaller companies whose key market positions and robust growth projections may signal greater potential for investors.
Among them are these six:
TransDigm Group Inc. (TDG)
- Projected average annual earnings growth over five years, according to FactSet: 26%
- Market cap: $48 billion (as of mid-November)
TransDigm designs and manufactures original aircraft parts for manufacturers and aftermarket replacement parts for operators of commercial and military aircraft. Most of its revenue is from civilian aviation sources. The company is benefiting from the integration of global economies, which is spurring jetliner fleet additions, and from pricing power as the sole supplier of some items. Though its trailing 12-month price/earnings ratio is high, at 47, this multiple has been pushed up by stock price growth of about 15% over the past six months, as of mid-November.
Parsons Corp. (PSN)
- Projected five-year annual earnings growth: 13%.
- Market cap: $6.5 billion.
This global technology company gets most of its revenue from federal agencies, both defense and civilian. Parsons Corp. clients include the U.S. Department of Defense, the Missile Defense Agency, the State Department, Department of Homeland Security, the Department of Energy and the Federal Aviation Administration. Products and services include items to counter unmanned air systems, and gear for national security, bio-surveillance, space launches, border security, rail design/control and infrastructure engineering. The stock prices has increased about 36% over the past six months, bringing the trailing P/E up to 48.
Howmet Aerospace (HWM)
- Projected five-year annual earnings growth: about 22%.
- Market cap: nearly $19.9 billion.
About 30% of Howmet's revenue is from defense. This is a manufacturer of lightweight jet-engine components, aerospace fastening systems, titanium aircraft parts and forged wheels. Its largest customers are commercial aircraft and jet engine manufacturers. Thus, this stock has more cyclical risk than more military-intensive companies. However, Howmet's EBITDA (earnings before interest, taxes, depreciation and amortization) is up 16% this year, and order-flow momentum is highly positive. Trailing P/E: 31.
Curtiss-Wright Corp (CW)
- Projected five-year annual earnings growth: Data was not available.
- Market cap: about $7.8 billion.
CW has the best downside-risk/forward-performance metrics of all aerospace/defense stocks. Curtiss-Wright provides engineered products and services for the defense, industrial and global power-generation markets. Most defense companies are located in Virgina (near government clients in Washington), but Curtiss-Wright is headquartered in Davidson, N.C. Products include throttle-control devices, joysticks, transmission shifters, sensors and electro-mechanical actuation components used in commercial and military aircraft. Pure defense lines include turret-aiming and stabilization items, weapons-handling systems, communications gear and naval ship items, including airlock hatches and products for spent-nuclear-fuel management and propulsion parts. CW also provides services for ship repair and maintenance. Despite a stock price increase of more than 20% over the last six months, solid earnings have kept this company's trailing P/E under 23.
Woodward Inc. (WWD)
- Projected five-year annual earnings growth: 13.2%.
- Market cap: $7.94 billion.
Woodward designs and manufactures mechanical control items for aviation and industry, both original equipment sold to manufacturers and replacement parts for operators. Products include fuel pumps, metering units, valves, nozzles, motors and sensors. Woodward also makes thrust-reversal systems for military aircraft and helicopters and commercial and private civilian aircraft and flight-deck systems for aircraft carriers. Industrial items include products for gas and steam turbines and compressors. This is another non-D.C. area company, located in Fort Collins, Colorado. Trailing P/E: about 39, with share price growth of more than 18% over the last six months.
Huntington Ingalls Industries (HII)
- Projected annual five-year earnings growth: 24%.
- Market cap: $9.3 billion.
A pure defense play, Huntington Ingalls Industries is primarily a warship company with a focus on aviation, as it builds aircraft carriers. More than 82% of its revenue is from the Navy, though it also manufactures and services Coast Guard vessels. Long time frames for producing Naval ships may make HII's revenues more predictable. The company's ultimate product is the 1,106-foot nuclear-powered aircraft carrier, U.S.S. Gerald R. Ford. The latest in carrier technology, this ship can support up to 90 aircraft, including F-35s and other fighter jets, as well as helicopters and unmanned aerial vehichles (aka drones). In the water since 2013, the Ford was the subject of news coverage in October when the Pentagon deployed it to Mediterranean coast off Israel as a deterrent to Iranian involvement in the Israeli-Hamas conflict. The company is currently touting its status as the manufacturer of "the Gerald R. Ford class" of carriers. Trailing P/E: 17.7, even with a stock price increase of about 18% over the past six months.
Commercial air travel demand 'still playing out'
Long-term forecasts for these companies are quite positive. And with post-pandemic demand for air travel still playing out, those with civilian aircraft business currently have diversified revenue. Yet wars can mean lower demand for commercial air travel in affected regions.
Nevertheless, the market positions of those with substantial defense revenue — derived from their status as sole or primary suppliers, developers of unique technology and established records as DOD partners — make them perennially investable propositions for long-term investors.
—Dave Sheaff Gilreath, a certified financial planner and the founding partner and chief investment officer of Sheaff Brock Investment Advisors and Innovative Portfolio, an institutional money management firm.
