Now that the 2023 fiscal year budget for the Pentagon has been set at a record $858 billion, it is time to take a look at opportunities for investors to share in the good times.

There are concerns in some quarters related to the concessions new House Speaker Kevin McCarthy had to make in order to gain his position. For fiscal 2024, McCarthy agreed to demands that tie an increase in the U.S. debt ceiling to cuts in discretionary spending and, more important to the Pentagon, a cap on the 2024 defense budget at the same level as fiscal 2022, about $75 billion below the 2023 level. Either of these could lead to a government shutdown, a full-year continuing resolution for FY 2024 or a default on the U.S. debt. The latter is virtually unthinkable, but the other two have historical precedents, neither particularly pleasant.

And good times they are. According to Michael Ciarmoli and his team at Truist Securities, “[T]he demand environment and global spending backdrop for the defense sector is the best we have seen on record.” Defense spending will not be subject to congressional wrangling over a continuing resolution, and even a divided Congress cannot do much to change that.

Truist’s analysts anticipate a 5% to 6% compound annual growth rate in NATO defense spending through 2026 as a reaction to the Russian invasion of Ukraine. That is expected to drive growth in sales to foreign governments and backlog growth for U.S. defense contractors.

A recession, or something that closely resembles one, is among the assumptions Ciarmoli and his team make. Others are continuing inflation and supply chain challenges at least through the first half of 2023. The defense sector, they believe, has been “de-risked, supply chain headwinds will ease and are in no way an indication of structural pressure, and top/bottom line growth will accelerate given the spending backdrop.”

In a cautionary moment, the analysts warn that “putting new money to work ahead of 4Q22 earnings season poses an unnecessary risk.” They also note that they do not expect to change ratings “abruptly or frequently” this year and believe that “investors should employ a trading mentality given current conditions.”

From their coverage universe, Truist’s analysts call out three defense stocks and two aerospace aftermarket suppliers as favorites. Here is a brief look at each.

L3Harris

Since the L3 and Harris merger in 2019, L3Harris Technologies Inc. (NYSE: LHX) has striven to become the sixth U.S. prime defense contract, joining Lockheed Martin, Raytheon, Northrop Grumman, Boeing and General Dynamics in an elite group. Its offer last month to acquire Aerojet Rocketdyne for $4.7 billion ($58 per share) could do the trick. If completed, the deal would create a company with a market cap of around $45 billion.

Truist has raised its price target on the stock from $258 to $264 (the average of 20 analyst firms is $264.67) and maintained its Buy rating on the shares. Excluding the effect of the pending acquisition, Truist raised its 2024 earnings per share (EPS) estimate on the shares to $12.98. Including an estimated $1.88 in Aerojet EPS for that year, the combined total would be around $14.90 compared to an estimate of $12.78 for L3Harris alone in 2023.

Cleveland-based TransDigm Group Inc. (NYSE: TDG) designs, produces and supplies specialized aircraft parts. The company operates in two segments: power and control and airframes. TransDigm ran into some trouble with the Pentagon last year when the Defense Department requested a refund of nearly $21 million in excess profits on 153 sole-source contracts from 2017 through the first half of 2019. The issue has not yet been resolved.

Truist’s analysts favor the aftermarket space in the commercial aerospace sector rather than equipment manufacturers for investors looking for a play in aerospace. Truist has a Buy rating on the stock and just raised its price target from $700 to $710, still below the $714.23 average target of 18 analyst firms. Fiscal 2023 EPS are forecast at $21.88, in line with the consensus, and fiscal 2024 earnings are pegged at $25.34, below the consensus of $26.48.

BWX Technologies

Unlike L3Harris and TransDigm, both large-cap stocks, BWX Technologies Inc. (NYSE: BWXT) is a mid-cap stock with a value of around $5.3 billion. The company manufactures and sells nuclear components through three segments: nuclear operations, nuclear power and nuclear services. The company’s products are critical to the U.S. nuclear navy and, in December, it began producing nuclear fuel for the first U.S.-built and operated microreactor that is expected to be delivered next year.

While BWX’s prospects for 2023 have been reined in somewhat, Truist believes that the catalysts and opportunities for growth “abound for this pillar of stability monopolistic asset.” The analysts have a Buy rating on the company and a price target of $70. That is slightly higher than the average of seven analysts with a consensus target of $67.57. Truist estimates 2022 EPS at $3.14 and 2023 EPS at $2.94, both in line with consensus estimates.

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Mercury Systems and AerSale

Mercury Systems Inc. (NASDAQ: MRCY) and AerSale Corp. (NASDAQ: ASLE) are small-cap aftermarket parts and components suppliers for the aerospace and commercial aircraft industries. Mercury is included in Truist’s list of favorites for its defense business, and AerSale operates primarily in the commercial sector. Mercury’s market cap is about $2.7 billion, and AerSale’s is about $842 million.

Mercury, which relies heavily on semiconductors, has been challenged by supply chain issues, but Truist believes the company will bounce off a bottom, that the long-term story remains solid and that share trades at a discount to its peers. The analysts have a price target of $69 on the shares and a Buy rating. Truist’s target is well above the average of $55 from 10 firms. Truist sees EPS of $2.00 this year and $2.72 next year, above the consensus estimates of $1.90 and $2.34, respectively.

AerSale’s price target was raised from $19 to $23, while its Buy rating was left alone. The analysts call AerSale a “unique mid-life aftermarket service provider” and that FAA approval and additional sales “have the potential to create a growth inflection.” Truist forecasts 2022 EPS at $1.22 and 2024 EPS at $1.30, above the consensus forecasts of $1.16 and $1.25, respectively. The consensus price target on the stock is $20.75.

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