UBS Very Cautious on Defense Stocks: Entire Sector Near All-Time Highs

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Despite budget cuts and battles within the Congress, the defense sector has spent the past two years chugging higher despite the potential cost cutting overhang. In a very volatile political year, which will include the crucial midterm elections, the subject is sure to come up again. The defense analysts at UBS think that could be the least of the worries the industry may be facing, especially when the stocks in their coverage universe are trading at historical highs.

In a new research report, the UBS team points out that consensus expectations for the defense industry have moved higher on the back of pension upside, with the stocks getting full credit as multiples expand further. Defense 2014 guidance incorporates about a 10% decline in pre-pension earnings before income taxes (EBIT), worse than 3% decline in 2013, and widely seen as conservative. The analysts think guidance is less conservative than it appears and that the cycle of “beats and raises” is likely to narrow from here. All in all, it may be time for investors to take profits and move on.

When your earnings guidance is better just because your pension obligations are not as onerous, it may definitely be time to sell and look for greener pastures. Here are the current ratings for the top defense names at UBS.

Alliant Techsystems Inc. (NYSE: ATK) is one of just two defense stocks still rated as a Buy at UBS. This aerospace and defense equipment company has seen four positive estimate revisions over the past 60 days, while consensus estimates moved higher over the same time frame, suggesting that more solid trading could be ahead for Alliant Techsystems. Investors are paid a 1% dividend. The UBS price target is $160. The Thomson/First Call estimate is $145.40. Shares closed Wednesday at $129.53.

Boeing Co. (NYSE: BA) was a top name last year, and valuation may be the main call at UBS. While the company is forging ahead with the new 737 Max and 767 models, continued problems with the 787 Dreamliner are still plaguing the aerospace giant. Investors are paid a 2.2% dividend. UBS rates Boeing at Neutral and has a $140 price target. The consensus target is $153.09. Boeing closed Wednesday at $128.39.

General Dynamics Corp. (NYSE: GD) is the only other defense name to be a stock to Buy at UBS. Strong orders from overseas customers are helping to offset the decline in domestic defense spending. While orders have improved, the company’s backlog is flat with last year’s numbers. Investors are paid a 2.24% dividend. The UBS price target is $118, and the consensus target is $111.76. The stock closed Wednesday at $105.26.

Lockheed Martin Corp. (NYSE: LMT) is a Sell-rated stock at UBS. This again, is most likely a straight valuation call at UBS. With the stock trading near 52-week highs and the ability to drive earnings appreciably higher, the money plain and simple may have been made on this name. Investors are paid a 3.3% dividend. The UBS price objective is $137, and the consensus is at $159.65. The stock closed at $162.65.

Northrop Grumman Corp. (NYSE: NOC) is rated Neutral at UBS. The company is the sixth-largest defense contractor by sales. Those sales fell pretty dramatically in the fourth quarter to $478 million from $533 million in the year-ago period. Investors are paid a 2% dividend. The UBS price target is $112, and the consensus target is $119.88, higher than Wednesday’s close of $119.05.

Raytheon Corp. (NYSE: RTN) is also Neutral-rated at UBS. Despite large contract sales to the Saudi’s, the company may very well be another valuation call from the UBS team. Raytheon is also trading right near 52-week highs. Investors are paid a 2.3% dividend. The UBS price target is $90, and the consensus target is $97.28. Raytheon closed Wednesday at $95.16.

Despite last year’s sequester and numerous walls of worry to climb, the defense and aerospace names have shined. The basic call from UBS is that most of the money has been made. Again, when lower pension obligations are the reason earnings are driven higher, and most of the names are trading at 52 week and all-time highs, it just makes sense to take profits. One good thing to do is follow the rule for a winning stock. Sell half and keep half. If it goes higher, you are a genius. If it goes lower, you are also a genius.

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