UBS Says Defense Growing Much Faster Than Expected: 4 Top Picks to Buy Now

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We have written about how some feel that the defense budgets in the Trump administration may end up being higher than many are expecting, but when you evaluate the defense/aerospace sector you have to consider all the subsectors, which include commercial aerospace, aftermarket and business jets. The smart thing for investors to do is find out which silo is growing the fastest and then put your chips on the top plays in that arena.

A new UBS research report makes the case that the actual defense sector itself is growing faster than they expected and could perhaps be the place that holds the most upside potential. While some of the companies look expensive on a price-to-earnings basis, UBS feels they are less so on a free-cash-flow basis. The report also notes that the stronger dollar is a negative that makes commercial aircraft more expensive, so companies less leveraged to that subsector may perform better.

Four companies are top picks at UBS, and all are rated Buy. They are listed in order of preference.

Huntington Ingalls

This company is somewhat off the radar, but it also has outstanding upside potential. Huntington Ingalls Industries Inc. (NYSE: HII) engages in designing, building, overhauling and repairing ships primarily for the U.S. Navy and the U.S. Coast Guard. It is involved in the design and construction of non-nuclear ships, comprising amphibious assault ships that include deck amphibious ships and transport dock ships; surface combatants; and national security cutters.

The company also provides nuclear-powered ships, such as aircraft carriers and submarines; refueling and overhaul, and inactivation services for nuclear-powered ships; and fleet support services comprising depot maintenance, modernization, repairs, logistics and technical support and planning yard services for naval and commercial vessels.

In addition, the company offers naval architecture and marine engineering, ship system assessment, maintenance engineering and logistics services; and a range of support services to commercial nuclear power plants, nuclear energy facilities and fossil power plants and other industrial facilities.

Shareholders receive a 1.13% dividend. The UBS price target for the stock is $225, and the Wall Street consensus price objective is $213.36.Shares closed Friday at $211.70.

General Dynamics

This company, like other major defense prime contractors, has had a very solid year and remains one the best ideas at UBS 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.

Shareholders receive a 1.76% dividend. The $215 UBS price target compares with the consensus target of $203.06. Shares closed Friday at $190.84.

Raytheon

This company has a diversified mix of business and also remains a favorite at UBS. Raytheon Corp. (NYSE: RTN) is an industry leader in defense, government electronics, space, information technology and technical services. The analysts have noted that the strong demand for missiles is a big positive for the company as domestic bookings were up 18%.

UBS likes the improved bookings and the working capital opportunities. The company reported mostly inline fourth-quarter results, and forward guidance also matched the analysts’ expectations.

Shareholders receive a 1.9% dividend. UBS has a $173 price objective. The consensus target is $167.56, and shares closed Friday at $154.38.

Orbital ATK

This is one of the two publicly traded companies with core rocket propulsion exposure. Orbital ATK Inc. (NYSE: OA) develops and produces aerospace, defense and aviation-related products to the U.S. government, allied nations, prime contractors and other customers in the United States and internationally. It operates through three segments.

The Flight Systems Group develops rockets that are used as small- and medium-class space launch vehicles to place satellites into Earth orbit and escape trajectories; interceptor and target vehicles for missile defense systems; suborbital launch vehicles that place payloads into various high-altitude trajectories; rocket propulsion systems for human and cargo launch vehicles; strategic missiles; missile defense interceptors and target vehicles; composite structures for military and commercial aircraft and launch structures markets; and illuminating flares and aircraft countermeasures.

The Defense Systems Group develops and produces military ammunition; small-caliber commercial ammunition; precision weapons and munitions; high-performance gun systems; propellant and energetic materials; propulsion systems for tactical missiles and missile defense applications; strike weapons; aircraft survivability systems; fuzes and warheads; special mission aircraft; airborne missile warning systems; and defense electronics.

The Space Systems Group offers small- and medium-class satellites that are used to enable global and regional communications and broadcasting; conduct space-related scientific research; and perform other activities related to national security. This segment also provides human-rated space systems for Earth-orbit and deep-space exploration, including resupplying the International Space Station, and spacecraft components and subsystems, as well as specialized engineering and operations services.

Top Wall Street analysts see the company as a key asset for national security and feel it has among the best valuation in the group.

Shareholders receive a 1.3% dividend. The UBS price target is $100. The consensus target is $109.89. Shares closed Friday at $99.47.

These four companies represent the very best in the industry, and their stocks make very good sense for long-term growth accounts. All have had strong runs since the election, despite recent underperformance, so investors may want to buy partial positions here and see if a correction doesn’t lower prices.