The aerospace and defense sector stocks have been crushed along with the rest of the market, and unlike volatile tech stocks that get caught up in global trade concerns, the top stocks are rarely subject to tariffs. Yet the sector is down a stunning 20% since October 1. With investors concerned over the prospects for many S&P 500 companies going forward, the defense and aerospace companies may offer the best value now.
The analysts at SunTrust feel that the assumption that spending on the sector has peaked has contributed to the massive sector sell-off, and they make the case that forward multiples have compressed substantially. Their recent report noted this:
In a reversal from recent commentary, the plan now (Trump and Defense Secretary Mattis have agreed) calls for defense spending of $750 billion in 2020, well ahead of the initial plan of $733 billion and takes off the table the thought that spending has peaked, and all the fear and rhetoric that the fiscal 2020 budget was going to be cut seems to be off the table. Look for a budget submission in February of ~5% increase over the 2019 level and while likely to still be a fiercely contested debate with democrats, the likely trajectory of the budget, and given multiple compression and the extreme sell-off, the Sun Trust analyst would expect the entire Defense sector to rally.
The SunTrust analyst Michael Ciarmoli is very positive on these three top companies, all rated Buy.
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FLIR Systems
This stock offers excellent upside potential and a moderate valuation. FLIR Systems Inc. (NASDAQ: FLIR) designs, develops, markets and distributes thermal imaging systems, visible-light imaging systems, locater systems, measurement and diagnostic systems and threat-detection solutions. The company’s segments include Surveillance, Instruments, Security, OEM & Emerging Markets, Maritime and Detection.
The Instruments segment provides devices that image, measure and assess thermal energy, gases and other environmental elements for industrial, commercial and scientific applications under the FLIR and Extech brands. The OEM & Emerging Markets segment provides thermal imaging camera cores and components. The Maritime segment develops and manufactures electronics and imaging instruments, and the Security segment develops and manufactures a range of cameras and video recording systems.
The SunTrust price target for the stock is $60, and the Wall Street consensus figure is $58.63. Shares closed Monday at $44.05.
L3 Communications
This is among the companies that most Wall Street analysts are very positive on. L3 Communications Holdings Inc. (NYSE: LLL) provides aerospace systems and a range of communication and electronic systems and products used on military and commercial platforms in the United States and internationally.
The company operates in three segments: Electronic Systems, Aerospace Systems and Communication Systems. It offers a range of products and services, including components, products, subsystems and systems, as well as related services to military and commercial customers in business areas, including precision engagement and training, power and propulsion systems, aviation products and security systems, sensor systems, warrior systems, and optics, telescopes and precision optical subsystems.
L3 Technologies produces electro-mechanical and mechanical fuzes to support missiles and artillery systems that enable for high-speed and high-accuracy sensors. Raytheon’s AIM-9X Sidewinder missiles bolster L3’s fuzing capabilities. It is expected to see some ancillary revenue from the huge Saudi deal signed last year.
SunTrust has a $232 price objective, while the consensus target price is $239.46. The shares closed Monday at $183.65, up almost 3% on the day.
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Mercury Systems
The SunTrust team sees 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.
The company 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.
The $61 SunTrust price target compares with the $55 consensus target and the most recent close at $49.11.
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Given the volatile situations around the globe, and the big foreign purchasing, the sector remains a good place to keep capital in growth portfolios. However, with the market still very precarious, it may make sense to scale-buy shares now and going forward.
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