Aerospace & Defense

After a Strong 2019, Are There Any Undervalued Defense Contractors?

Last week, the U.S. Senate passed the National Defense Authorization Act (NDAA), clearing the way for the president to sign the defense spending bill into law before Congress takes its annual holiday vacation. The House of Representatives passed the 3,488-page legislation previously. This is the 59th consecutive year that Congress has finalized and passed an NDAA.

Major components of the NDAA were a $635 billion allocation for Department of Defense and Department of Energy national security programs, $71.5 billion for overseas contingency operations (OCO, or fighting in foreign wars) and $5.3 billion to repair damage caused by extreme weather and natural disasters. The Defense Department’s full fiscal year 2020 budget totals $738 billion, an increase of $22 billion ($3.1%) year over year.

The NDAA also included about $40 million to create a sixth armed service, U.S. Space Command, formerly known as the Air Force Space Command. The funds likely will pay for changing the Space Command’s letterhead and signage and not much else.

With an annual budget of more than $700 billion, it may seem odd that a 10-year, $10 billion award for a defense cloud contract should get so much attention. Microsoft Corp. (NASDAQ: MSFT) snatched the contract from the grasp of Inc. (NASDAQ: AMZN) in a decision that Amazon complains was politically motivated and not made on its merits. A lot more funding than that was at stake as the NDAA rolled toward approval.

Here’s a look at the nation’s top 10 defense contractors and how their prospects are shaping up for 2020. The revenue data comes from the Defense News list of the top 100 defense firms of 2018, the last year for which the data is available.

Lockheed Martin Corp. (NYSE: LMT) is the country’s largest recipient of federal spending. In 2018, the last year for which data is available, Lockheed had $50.54 billion in defense-related revenues, representing 94% of the company’s total revenue for the year. The NDAA, among other things, calls for the company to deliver 98 F-35 Joint Strike Fighters next year at a total cost of $1.87 billion. As of Friday’s close, Lockheed stock had gained nearly 46% for the year to date. Based on a consensus price target of $404, the implied upside to the company’s share price is around 5.4%.

Boeing Co. (NYSE: BA) piled up $34.05 billion in defense revenues in 2018, 34% of the company’s revenue total for the year. The company’s well-known troubles with its 737 Max passenger jet have dominated news from Boeing this year, but the company’s KC-46 tanker also had some troubles. The NDAA calls for 12 of the tankers to be delivered next year but also prohibits the retirement of the RC-135 and KC-10 tankers the new Boeing tanker is supposed to replace. Even given the beating the company has gotten over the 737 Max, the share price remains about 1.3% higher for the year. Based on a 12-month consensus price target of $369.15, the implied upside is 12.5%.

Northrop Grumman Corp. (NYSE: NOC) posted defense sales totaling $25.3 billion in 2018. That comprised 84% of the firm’s total revenues for the year. Northrop acquired Orbital ATK last year for $9.2 billion and is on its way to securing a 20-year, $63 billion Pentagon contract to develop the Ground-Based Strategic Deterrent program that replaces more than 400 Minuteman ICBM missiles. (Boeing withdrew from consideration, claiming the deck was stacked in Northrop’s favor.) Northrop’s shares have added just over 40% to date this year, and with a consensus price target of $397.06, the company’s implied upside based on Friday’s closing price of $345.91 is 14.8%.

Raytheon Co. (NYSE: RTN) hauled in $25.16 billion in defense revenues last year, accounting for 94% of the firm’s total annual sales. The company’s proposed $74 billion merger with United Technologies is expected to close in 2020, creating the country’s second-largest defense firm (behind Lockheed) based only on defense revenues. Raytheon’s stock has added just over 41% so far in 2019, and based on a price target of $228.07 per share, the stock’s implied upside is 4.9%.

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