Defense contractors

[Spekulatius]

I agree in principle that the entire defense industry is cheaply priced relative to the market. Some of these companies give me deja vu to investing back in 2012. Earning multiples below 15 are common, share buybacks, dividends, it seems almost guaranteed money. I am long GD but I think there are even cheaper and better equities in defense. 

 

You can buy a basket to mitigate company risk but beyond how do you assess risk?  The only risks I see is that defense budgets get cut. It seems very unlikely to me but who knows.  Perhaps some epic accord is signed with China and Russia to demilitarized.  It seems things are going the opposite direction if anything. 

 

I am sold on the thesis, now looking for contrary opinions. In particular from the dem side of the board since they now control the checkbook.

 

I own NOC, LHX, LMT and GD (in that order). I was initially overweight GD (actually bought some as low as $100 and change) but reduced in favor over the others.

 

The risk that is Common with all of them is cuts in defense spending. air is possibility, but with MMT now making the rounds and threats from China and to a lesser extend Russia increasing in their sophistication it seems like a bad idea right now.

 

If cuts in defense spending were going to happen, I expect another round of rationalization and consolidation and massive share buybacks just like what happened from 2010-2013. Consolidation will perhaps not amongst the prime contractors but all those secondary ones underneath. Those mostly are not pure play defense, they will just move resources to other areas. I work for what is one of the secondary ones (supplying the big ones with components so to speak) and I know for sure that if the business gets subscale, the effort is just going to be moved into commercial activities.

[Spekulatius]

Potus defense proposal is out - calls for 1.8% increase. Seems bullish considering the low expectations:

https://www.politico.com/news/2021/04/08/biden-pentagon-budget-480476

[scorpioncapital]

8 hours ago, Spekulatius said:

Potus defense proposal is out - calls for 1.8% increase. Seems bullish considering the low expectations:

https://www.politico.com/news/2021/04/08/biden-pentagon-budget-480476

If inflation is or is likely to be 2 to 3% as the Fed wants, wouldn´t 1.8% be below inflation growth rate, thus a decrease in real terms? True it´s only for 1 year but already we can say it is negative real growth rate. I guess you could hold defense stocks as bond equivalents but it isn´t very ambitious. One could expect perhaps a slight positive return, better than holding say government debt but that isn´t saying much. 

Edited April 11, 2021 by scorpioncapital

[Spekulatius]

5 hours ago, scorpioncapital said:

If inflation is or is likely to be 2 to 3% as the Fed wants, wouldn´t 1.8% be below inflation growth rate, thus a decrease in real terms? True it´s only for 1 year but already we can say it is negative real growth rate. I guess you could hold defense stocks as bond equivalents but it isn´t very ambitious. One could expect perhaps a slight positive return, better than holding say government debt but that isn´t saying much. 

The news is good, because the expectations were for a flat budged and 1.8% growth is better than flat.

The defense contractors don’t really need much growth to generate good returns for shareholders. When you look at historical data, the growth in the defense budget wasn’t all that great (less than GDP), yet through a combination of higher budget share, dividends and stock buybacks, double digit returns have been achieved for shareholders.

 

From current levels I can see returns of about 10% for LHX, LMT and NOC going forward, which I think will be far higher than what can be expected from the SPY.

[Spekulatius]

NOC results were quite strong, due to new programs contributing ( GBSD, space, classified) so this is just a friendly reminder (thanks to @lhamtil from Twitter) that NOC has beaten the QQQ over the last 10 years as well as 20 years (NOC has underperformed the QQQ since 2018 though).

 

Edited May 6, 2021 by Spekulatius