Al Root
The Russian invasion of Ukraine didn't kick-start a significant rally in defense stocks. Is the current geopolitical tension any different?
The answer is no, probably not. That doesn't mean investors should avoid defense stocks. There's opportunity.
The U.S. defense budget for fiscal 2024, which ends September, calls for $824 billion in spending, up about 3% from fiscal 2023. The fiscal 2025 budget proposal calls for $850 billion, up another 3%. The growth rate hasn't been impacted that much by recent global conflict.
The Federal Government looms large for all U.S. defense players. Take Lockheed Martin. It generates roughly three-quarters of sales from the U.S. government with about 90% of that -- or two-thirds of its total -- coming from the Defense Department.
Including all supplemental spending and aid, the U.S. is spending about $1 trillion a year on defense, according to Federal Reserve data. Spending has risen consistently for the past eight years, up about one-third from a relative low in 2016.
Eight years is a lengthy expansion, but it isn't unprecedented. Spending rose consistently for about 12 years between 1999 and 2011. Overall, the setup for defense stocks looks fine, but not as good as other points in recent history.
Investors will need to be selective. Since Russia invaded Ukraine, shares of major U.S. defense contractors are up about 13% on average. The S&P 500 is up about 18%. Two standouts have been shares of General Dynamics and Huntington Ingalls Industries, up about 30% and 26% over that span, respectively.
Both make products for the Navy. Shipbuilding has been a relatively safe part of the U.S. Defense budget. Huntington has also improved operating profit margins and General Dynamics has a successful Gulfstream private jet business.
Lockheed stock has fared well, keeping up with the S&P 500 since Ukraine, but shares have hit a rough patch lately. Coming into Monday trading, Lockheed stock is down about 8% over the past 12 months.
J.P. Morgan analyst Seth Seifman sees that turning around. Monday, he upgraded Lockheed stock to Buy from Hold, and lifted his price target to $518 from $475.
He noted that slowing military spending growth was a headwind for shares, but other challenges, including low F-35 deliveries and financial charges related to classified missile programs, should end soon.
Defense sentiment can help too. "Any change in market momentum would likely leave Defense stocks -- for which Lockheed is the bellwether -- well-placed in relative terms," wrote Seifman.
Lockheed stock is up 1% in Monday trading at $454.90 following the bullish call. The S&P 500 and Nasdaq Composite are flat.
Other analysts are a little more skeptical than Seifman about Lockheed. Overall, 20% of analysts covering Lockheed stock have Buy ratings. The average Buy-rating ratio for stocks in the S&P 500 is about 55%. The average analyst price target for Lockheed shares is about $483.
Lockheed ratings show how Wall Street feels about defense these days. Spending trends have kept a lid on sentiment. Still, investors should pay attention to global conflicts, and consider if any will directly involve the U.S.
Write to Al Root at allen.root@dowjones.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
April 15, 2024 11:21 ET (15:21 GMT)
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