On February 24, Russian President Vladimir Putin announced a ‘special military operation’ in Ukraine. However, it was clear from his speech that the invasion was also meant to send a message to the United States and its allies, or the so-called “western bloc.” The west consequently responded with economic sanctions against Russia.
These increased geopolitical tensions due to the Russia-Ukraine conflict has pushed many nations to strengthen their defense budget. As of March 22, six NATO members have pledged defense spending increments of $133 billion, with more nations expected to jump on the bandwagon. Recently, President Biden proposed a 4% increase in spending for national defense to $813 billion in the spending package signed earlier this month to the fiscal year 2023 Pentagon budget, which now includes $813 billion in spending for national defense.
Given this backdrop, I’m going to analyze three prominent stocks within the aerospace and defense industry, Raytheon Technologies Corporation (RTX), Northrop Grumman Corporation (NOC), and General Dynamics Corporation (GD), that stand to benefit from the current situation.
The Defense Industry
The Defense industry sells air-based, sea-based, and land-based military equipment. Support and auxiliary equipment such as radar, satellites, sonars, and other auxiliary equipment also come under the industry’s purview. The global defense market is expected to grow at a CAGR of 6.8% to reach $483.47 billion in 2022.
The ongoing war has turned out to be a boon for the industry. American defense contractors should benefit from the increased western military spending to support forces at Kyiv. It can be expected that pushing more equipment in Ukraine would have to be backfilled by more spending on the Pentagon’s part.
Both large and small defense companies have risen to grab their share of the increasing defense budget. Loren Thompson, Lexington Institute COO and a defense industry consultant, said, “For the defense industry, happy days are here again. When the defense budget rises, it tends to lift all boats in the industry.”
SPDR S&P Aerospace & Defense ETF (XAR) has gained 10.8% since the war was announced on February 24, outpacing the 9.4% gains of the SPDR S&P 500 ETF Trust (SPY) over the same period. Also, the ETF’s 8.9% year-to-date gains have outpaced the broader market.
Performance of Major Industry Participants
Lockheed Martin Corporation (LMT) is one of the biggest names in the Aerospace and Defense industry. The stock has gained 23% year-to-date, outpacing the S&P 500’s 2.8% negative returns. LMT has a market capitalization of $116.52 billion.
In a coalition with RTX, LMT makes the Javelin anti-tank missiles, which are being supplied by the likes of the United States and Estonia. LMT’s shares soared after the war was declared. Aircraft-making relies heavily on lightweight materials like Titanium, which became scarce in supply with its major reserves in the warring nations. However, following the Crimean crisis of 2014, BA had begun stockpiling Titanium. In a statement issued on March 7, the company stated, “Our inventory and diversity of titanium sources provide sufficient supply for airplane production, and we will continue to take the right steps to ensure long-term continuity.”
Best Defense Stocks to Buy Now
Given the promising prospects of the defense industry, it could be wise to bet on the following fundamentally strong defense stocks:
Raytheon Technologies Corporation (RTX)
RTX operates as an aerospace and defense company that provides systems and services for commercial, military, and government customers. The company operates through the broad segments of Collins Aerospace Systems; Pratt & Whitney; Raytheon Intelligence & Space; and Raytheon Missiles and Defense.
For the fiscal fourth quarter ended December 31, RTX’s net sales increased 3.8% year-over-year to $17.04 billion. Adjusted income from continuing operations attributable to common shareowners and adjusted EPS came in at $1.61 billion and $1.08, up 43.9% and 45.9% from the prior-year period.
The consensus EPS estimate of $1.02 for the quarter ending March 2022 indicates a 13.3% year-over-year rise. The consensus revenue estimate for the same quarter of $15.97 billion reflects an improvement of 4.7% from the prior-year quarter. Moreover, RTX has an impressive surprise earnings history, as it has topped consensus EPS estimates in each of the trailing four quarters.
The stock has gained 30.1% over the past year and 17.5% year-to-date to close yesterday’s trading session at $101.08.
RTX’s strong fundamentals are reflected in its POWR Ratings. The stock has an overall rating of B, which equates to Buy in our proprietary rating system. The POWR Ratings are calculated by considering 118 different factors, with each factor weighted to an optimal degree.
RTX has a Growth grade of A, which is justified by its revenue and levered FCF growth at CAGRs of 22.9% and 69.4%, respectively, over the past three years. The stock has a B grade for Stability, in sync with its five-year monthly beta of 0.90. RTX also has a Sentiment grade of B. In the 73-stock Air/Defense Services industry, it is ranked #6.
Click here to see the additional POWR Ratings for RTX (Value. Momentum, and Quality).
Northrop Grumman Corporation (NOC)
NOC, operating through the segments of Aeronautics Systems; Defense Systems; Mission Systems; and Space Systems, provides aircraft systems for tactical intelligence, weapon and mission systems for the military, radar, electro-optical/infrared, and acoustic sensors.
NOC’s net earnings increased 721.2% year-over-year to $2.71 billion in the fiscal fourth quarter ended December 31. EPS rose 770.1% from the same period the prior year to $17.14. Adjusted free cash flow stood at $709 million.
Analysts expect NOC’s EPS to increase 8.9% year-over-year to $27.06 for the fiscal year 2023. Likewise, Street expects revenue for the same period to improve 3.5% from the prior year to $37.85 billion. In addition, NOC has topped consensus EPS estimates in each of the trailing four quarters, which is impressive.
The stock has gained 38.1% over the past year and 15.3% year-to-date to close yesterday’s trading session at $446.31.
It’s no surprise that NOC has an overall B rating, which translates to Buy in our POWR Rating system.
NOC has a Quality grade of B, justified by its trailing 12-month ROE of 59.60%, which is 335.68% higher than the industry average of 13.68%. Its trailing 12-month levered FCF margin of 18.11% is 323.19% higher than the industry average of 4.28%. It is ranked #17 in the Air/Defense Services industry.
To see the additional POWR Ratings for Growth, Value, Momentum, Stability, and Sentiment for NOC, click here.
General Dynamics Corporation (GD)
GD is an aerospace and defense company operating worldwide. The company operates through the four broad segments of Aerospace; Marine Systems; Combat Systems; and Technologies.
For the fiscal year ended December 31, GD’s revenue increased 1.4% year-over-year to $38.47 billion. Net earnings rose 2.8% from the prior year to $3.26 billion. EPS improved 5% year-over-year to $11.55.
The consensus EPS estimate of $12.13 for the fiscal year 2022 indicates a 5% year-over-year increase. The consensus revenue estimate for the same year of $39.35 billion reflects a rise of 2.3% from the prior year. Analysts expect GD’s EPS to grow 11% per annum over the next five years.
The stock has gained 31.5% over the past year and 15.7% year-to-date to close yesterday’s trading session at $241.09.
This promising outlook is reflected in GD’s POWR Ratings. The stock has an overall B rating, equating to Buy in our proprietary rating system.
GD has a Sentiment grade of B, in sync with its favorable consensus estimates. The stock also has a Stability grade of B. GD is ranked #11 in the same industry.
In addition to the POWR Rating grades we’ve stated above, one can see GD ratings for Growth, Stability, Value, Momentum, and Quality here.
RTX shares rose $0.17 (+0.17%) in after-hours trading Wednesday. Year-to-date, RTX has gained 17.81%, versus a -3.12% rise in the benchmark S&P 500 index during the same period.
About the Author: Anushka Dutta
Anushka is an analyst whose interest in understanding the impact of broader economic changes on financial markets motivated her to pursue a career in investment research.
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