US Defense Companies Go On Overseas Offensive

A United States Army missile defense system, Terminal High Altitude Area Defense (THAAD).
Source: Department of Defense
A United States Army missile defense system, Terminal High Altitude Area Defense (THAAD).

To get an idea of just how important international markets have become to U.S. defense companies, look no further than what their executives were saying on their first-quarter conference calls:

Raytheon: "International continues to be a key differentiator for the company. In Q1, our international business represented 26 percent of our total sales."

Lockheed Martin: "We are on a path to grow international sales from approximately 17 percent of total revenues last year to at least 20 percent in the next few years."

Alliant Techsystems: "We have opened international offices with what I call 'feet on the street.'"

America's defense companies make a business out of defeating enemies, and with the federal government's budget shortfall perhaps the industry's Enemy #1 at the moment, companies are going on offense: They're courting new customers abroad.

On call after call over the last few weeks, management tried to assure Wall Street that budget cuts at home are being partially offset by new business overseas. "We have very nice and robust international orders that ought to bridge until the Army begins to re-capitalize," said General Dynamics CEO Phebe Novakovic.

Northrop Grumman echoed others when management said the sequester creates a "delayed effect" as it takes time for the cuts to make their way through to contracts. The real impact will be felt as future contracts are awarded, the company said. In anticipation of lost business, Goldman Sachs pointed out, "The focus on international opportunities remains persistent across the board."

Lockheed Martin, in particular, may feel compelled to reduce its dependence on Uncle Sam. The company gets 61 percent of revenue from the Department of Defense.

Lockheed just relaunched the website for the F-35 fighter jet in order to highlight interest by foreign buyers. Congress and the Pentagon continue to reconsider how many of the expensive jets to purchase, but Australia recently announced it would buy 100. On its earnings conference call with analysts, Lockheed CEO Marilyn Hewson said the company expects the F-35's international sales to help growth, but other programs should help as well.

"This quarter, I had the opportunity to meet with key customers in Israel, United Arab Emirates, Saudi Arabia and Italy," Hewson said. "Discussions centered on how our corporation can help them with their diverse spectrum of security needs that range from fighter aircraft to missile defense systems to cyber security."

Four Stocks Researchers Like

How is it playing out on Wall Street? Thomson Reuters analysis suggests investors are rotating into industrials, "with the aerospace and defense industry outgunning both the sector average and also the S&P 500 in total return year to date." The group is up over 17 percent through May 10.

Researchers highlight four stocks as particularly strong—Lockheed Martin, Boeing, General Dynamics and Raytheon. These four scored very high on StarMine's ranking of companies based on how likely past earnings can be sustained in the future. On a scale of 1 to 100, with 50 being the U.S. average, Lockheed scored a whopping 97, followed by Raytheon (94), Boeing (92) and General Dynamics (86).

Those figures may seem optimistic in an environment where the primary customer for all of these companies is cutting back. Stifel reported the Department of Defense cut spending on operations and maintenance last month for the 14th month in a row, and investment spending was down for the 10th straight month. But the firm raised its price target on Raytheon by $10 to $73 based in part on "strong international businesses" helping to drive "long-term EPS and cash flow growth and attractive dividend."

"You got to meet the market where the market is," said General Dynamics' Novakovic.