After what can only be described as an incredibly wild and wooly year for investors, many across Wall Street are cautiously optimistic for 2021, as most equity strategists see the country returning to a more normal state of affairs. The rollout of the vaccines and a reopening of the economy could very well jump-start growth, and one sector that is a very solid idea for growth stock investors is defense.
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A new Goldman Sachs research report includes the firm’s top defense picks for 2021, though oddly most of the “big name” defense players are not rated Buy. The analysts noted this:

US Defense investment authorization has now grown 50% off its 2013 trough, making comparisons difficult, while political priorities may shift and the US now faces a total government budget challenge following substantial stimulus spending. This makes defense budget growth look unlikely in the medium-term. However, the geopolitical threat environment also makes sizable reductions in the budget look unlikely, while the defense contractor business model remains particularly favorable through the various budget cycle backdrops. The relative valuation de-rating of 2020 also prices budget concerns in, to a degree.

This helps to explain their somewhat cautious stance, and despite the massive government spending in 2020, as they noted, the world is still a very dangerous place. It is important to remember that no single analyst report should be used as a sole basis for any buying or selling decision.

Kratos Defense and Security Solutions

While hardly a well-known name, this company offers investors an interesting silo. Kratos Defense and Security Solutions Inc. (NASDAQ: KTOS) provides mission critical products, solutions and services in the United States and internationally.

The Kratos Government Solutions segment offers microwave electronic products; space, training and cybersecurity products; C5ISR/modular systems; turbine technologies; and defense and rocket support services.

The company is also involved in engineering, developing and testing of gas turbines, propulsion components, engines and other systems for military and commercial applications, as well as focusing on development and production of jet engines for tactical weapon systems and jet unmanned aerial systems. Its Unmanned Systems segment provides unmanned aerial systems and unmanned ground and seaborne systems.

The analysts noted this about Kratos:

The tactical unmanned portfolio is set to begin a sustained period of growth driven by several ramping programs. Kratos was recently awarded the largest initial task order under the Skyborg program for their Valkyrie drone. We expect them to win substantial funding from subsequent task orders under the contact, but note that there are several programs under which the company could be granted funding. Additional program awards and milestones on other platforms such as Gremlins and Airwolf should solidify market confidence in the growth potential of the product offering. While we expect the tactical portfolio to be the primary driver behind sector-leading organic growth, the business is also exposed to other DoD priority buckets including Space, cyber, and hypersonics.

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Goldman Sachs has set a $25 price objective for the shares, which compares with the Wall Street consensus target of $24.40. The last trade on Thursday came in above both levels at $25.09, after almost a 7% gain on the day.

L3 Harris Technologies

This recently merged company is now the sixth-largest defense firm. L3 Harris Technologies Inc. (NYSE: LHX) is an agile global aerospace and defense technology innovator engaged in the provision of defense and commercial technologies across air, land, sea, space and cyber domains.

Its Integrated Mission Systems segment includes intelligence, surveillance and reconnaissance; advanced electro optical and infrared; and maritime power and navigation. The Space and Airborne Systems segment comprises space payloads, sensors and full-mission solutions; classified intelligence and cyber defense; avionics; and electronic warfare.

The analysts have been very positive on the stock this year and said this about the valuation discount:

The company is situated well in the high growth buckets of the Department of Defense budget, and we believe the business is not as short-cycle as the market has historically perceived. Merger synergies give the business a unique path to cash flow and margin upside along with above average revenue growth. The stock still trades at a meaningful discount to Lockheed Martin and Northrop Grumman despite a more attractive margin profile given the operating leverage of the commercial model.

Shareholders receive a 1.83% dividend. The Goldman Sachs price target is $216, but the $227 consensus figure is slightly higher. L3 Harris Technologies stock was last seen trading at $185.71.

This is one of the top aerospace and defense stocks to buy, and many on Wall Street are expecting a very solid continuation of U.S. and foreign defense spending in 2021. Lockheed Martin Corp. (NYSE: LMT) researches, designs, develops, manufactures, integrates, operates and sustains advanced technology systems, products and services. It also provides a wide range of defense electronics products and IT services.
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Being the Pentagon’s prime contractor, Lockheed Martin offers a diverse portfolio of global aerospace, defense, security and advanced technologies. Its leveraged presence in the Army, Air Force, Navy and IT programs guarantees a steady inflow of follow-on orders, not only from the U.S. government but also from many foreign allies of the nation.

Goldman Sachs feels this large-cap leader is still one of the best ideas, noting this in the research report:

Over the last several years, Lockheed Martin’s backlog has substantially outgrown the rest of the industry, supporting the growth outlook for the foreseeable future. The company has exposure to Department of Defense priority buckets, and consistently executes well. Even if the end market growth rate slows, we expect continued strong fundamentals, with compounding earnings and cash flows.

Investors receive a 2.95% dividend. The $451 Goldman Sachs price objective is above the $436 consensus target. Lockheed Martin stock closed at $352.60 on Thursday.

Mercury Systems

Many across Wall Street see this as one of the only pure-plays on defense electronics. Mercury Systems Inc. (NASDAQ: MRCY) provides secure processing subsystems for various critical defense and intelligence programs in the United States.

The company’s products and solutions are deployed in approximately 300 programs with 25 defense prime contractors. Its principal programs include Aegis, Patriot, Surface Electronic Warfare Improvement Program, Gorgon Stare, Predator, F-35 and Reaper.

Mercury Systems also designs, markets and licenses software and middleware environments under the MultiCore Plus name to accelerate development and execution of signal and image processing applications on a range of heterogeneous and multi-computing platforms.

Goldman Sachs has an $89 target price. The consensus target is $91.60, and the shares rose almost 3% on Thursday to close at $84.32.

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Given the volatile situations around the globe, and big foreign purchasing, the sector remains a good place to keep capital in growth portfolios. With the potential for a market top remaining precarious in 2021, it may make sense to scale buy shares now, a little at a time, and see how earnings for the fourth quarter come in.

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