Combine a very dangerous world with a president who is very pro-American business, and you have the perfect storm set for the defense and aerospace industry. Then, just to sweeten the pot some, add incredible international demand and the president’s desire to rebuild the own military, and the tailwinds for an industry already in solid shape look to stay that way for the foreseeable future.
In a new research report from Matthew McConnell, the outstanding defense and aerospace analyst at RBC, he and his team preview the upcoming second-quarter earnings from the stocks in their coverage universe. With $60 billion in approvals for foreign military sales from the government already in 2017, demand is more than strong enough. They noted this in the report:
International demand for defense equipment remains intense given geopolitical tensions across Asia Pacific, the Middle East, and in Eastern Europe, creating a healthy backdrop for the defense primes into second quarter earnings. We continue to believe the defense stocks within our coverage are positioned for a prolonged period of beats and raises as US defense budgets inflect higher and international demand remains robust, justifying the current 12% premium to the S&P 500.
General Dynamics
This company, like other major defense prime contractors, has had a very solid year and remains one the best ideas at RBC in the space. General Dynamics Corp. (NYSE: GD) is engaged in business aviation, land and expeditionary combat vehicles and systems, armaments, munitions, shipbuilding and marine systems, and information systems and technologies.
Major products include Virginia-class nuclear-powered submarine and Ohio class replacement, Arleigh Burke-class Aegis, Abrams M1A2 tank, Stryker 8-wheeled assault vehicle, medium-caliber munitions and gun systems, tactical and strategic mission systems.
The company reported stunning first-quarter earnings that were well above the analysts’ consensus estimate. The earnings beat was driven by better than expected margins and lower taxes.
The RBC team expects second quarter growth to be led by the Combat Systems group as international programs ramp up in Canada and the United Kingdom. They also feel the group will benefit from higher U.S. Army and Marine budgets.
Shareholders are paid a 1.67% dividend. The RBC price target for the stock is $220, and the Wall Street consensus target is $211.87. The stock closed Tuesday at $199.91 per share.
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Northrop Grumman
This company was ranked as one of the top five defense contractors by sales last year. Northrop Grumman Corp. (NYSE: NOC) provides innovative systems, products and solutions in unmanned systems, cyber, C4ISR and logistics and modernization to government and commercial customers worldwide.
The Aerospace Systems segment designs, develops, integrates and produces manned aircraft, unmanned systems, spacecraft, high-energy laser systems, microelectronics and other systems and subsystems. RBC sees the Aerospace divisions driving sales forward in the second quarter, and also notes the ramp-up in the F-35 fighter production. The team also cites the continued B-21 development work as a positive, despite the margin headwinds that they feel are factored in.
The Information Systems segment offers advanced solutions for Department of Defense, national intelligence and federal civilian, state, international and commercial customers. This segment provides products and services primarily in the fields of command and control, communications, cyber, air and missile defense, intelligence processing, civil security, health information technology and government support systems.
The Technical Services segment provides logistics, modernization, and sustainment services, as well as other advanced technology and engineering services, including space, missile defense, nuclear security, training and simulation services.
Shareholders are paid a 1.52% dividend. RBC has a $281 price target. The consensus target is $265.05, and shares closed Tuesday at $262.64.
Raytheon
This company has a diversified mix of businesses and remains a favorite at RBC. Raytheon Co. (NYSE: RTN) is an industry leader in defense, government electronics, space, information technology and technical services. The company operates in four principal business segments: Integrated Defense Systems, Intelligence, Information and Services, Missile Systems, and Space and Airborne Systems.
Top Wall Street analysts have noted that the strong demand for missiles is a big positive for the company as domestic bookings were up 18%. The company reported solid first-quarter results, with revenues up more than 3% year over year in the quarter and total backlog up more than 5%.
The RBC analysts feel that the company could be one of the biggest winners as the global threat environment has been heightened substantially this year, and with 31% of total sales from international, the prospects remain very positive. They cite the Patriot Missile deal recently signed with Poland as a good example that could propel 2018 earnings.
Raytheon shareholders receive a 1.96% dividend. The $181 RBC price objective compares with a consensus target price of $173.47. The shares closed Tuesday at $166.55 apiece.
TransDigm
This company was hitting our insider buying screens in a big way earlier this year. TransDigm Group Inc. (NYSE: TDG) is a holding company for different businesses that provide a diverse array of products including ignition systems, pumps, valves, motors, actuators, controls, water faucets and systems, quick disconnects and couplings, batteries, chargers and power conditioning, cockpit security systems, composites and elastomers, audio systems and lighting and displays.
While TransDigm remains a highly charged stock following a steady barrage of short reports, the stock has solid upside potential. The shares pulled back recently on market concerns around tepid organic commercial aftermarket growth, but they have since rebounded. Excluding four specific units, commercial aftermarket would have been up mid-single-digits and bookings exceeded shipments.
The RBC report said:
We are adjusting our model to include the acquisition of three add-on aerospace product lines that TransDigm announced it had acquired on June 1. The units had combined revenues of $32 million and the combined price of the acquisitions was $100 million. Given the small size of the deal and the close late in the quarter, this does not impact our fiscal third quarter 2017 estimate of $3.16 (consensus is $3.15). Our fiscal 2017 and 2018 EPS estimates are unchanged.
RBC has set its price target at $316, and the posted consensus target is $286.72. The stock closed Tuesday at $270.63.
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These are four top stocks to buy for investors looking to own defense and aerospace stocks. It should be noted the sector has run hard since the election, and any missteps could cause a sizable sell-off. With that in mind, the forward fundamentals look solid and should stay that way.
Top Gaining Stocks
Top Losing Stocks