Defense stocks have struggled despite a seemingly ideal backdrop for the sector: rising geopolitical tensions, war in the Middle East, earnings growth, and improving outlooks.
Recent declines have left several stocks looking attractive, according to Wall Street. But one large defense contractor looks better than the others right now.
L3Harris Technologies stock sank almost 9% on Thursday after the company reported earnings the previous evening. Given the reaction, investors might assume earnings were bad. They weren't. In fact, unadjusted earnings per share grew 28% from a year earlier and beat Wall Street estimates, plus the company raised full-year financial guidance.
There was one problem announced with earnings: The company delayed the initial public offering for its missile-related business, citing "market conditions."
Those conditions likely are defense technology stocks' collapsing multiples. L3Harris stock trades for about 20 times earnings estimates over the coming 12 months. That's down from around 30 times as fighting broke out in Iran.
The war has had a curious effect on the defense sector. Stocks are down, despite booming business for missiles and drones. Investors appear worried that the spending growth will slow after the relatively unpopular war winds down.
But that drop-off in spending hasn't materialized yet. In fact, spending on drones and missiles continues to grow, which leaves large defense stocks trading at interesting levels. The average analyst price target for L3Harris stock sits at about $366 per share, up from about $302 a year ago, according to FactSet. That implies gains of 35% from recent levels around $272.
That is the largest gap between current prices and analyst price targets among large U.S. defense contractors, including Northrop Grumman, Lockheed Martin, General Dynamics, and Huntington-Ingalls Industries.
The price targets for each stock are up an average of 23% over the past year. The stocks, however, have gained 13% in that span. (L3Harris and Northrop are down over the past 12 months.)
That situation has left the average expected gain based on price targets at about 17%, up from 7% a year ago.
L3Harris is also the most popular stock among analysts, with 71% of them rating shares Buy. The average Buy-rating ratio for stocks in the S&P 500 ranges from about 55% to 60%. The average Buy-rating ratio for the other defense contractors is about 56%.
Analysts' opinions change, of course, and price targets are only one way to identify opportunities. Still, L3Harris stock looks the best to Wall Street. Investors just don't seem to agree.
Honorable mention goes to smaller-capitalization autonomous and drone technology company Kratos Defense & Security Solutions. Its average analyst price target is about $106, up from $57 a year ago. The stock, however, is off 21% over the past 12 months, leaving shares about 57% below the average target price and implying 130% gains.
Kratos stock traded for more than 160 times earnings before the Iran war. Now it trades for less than 50 times earnings, in another example of the wild trading in the defense sector lately.
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