Aerospace & Defense

Why Mega-Cap Defense Stocks May Be the Best Idea for the Rest of 2020

Technology has swept investors up over the past few years. With the mega-caps all posting solid results last week, many investors are looking for somewhere to move capital. While tech will continue to roll, the same may not be said for the rebound in the economy. The extra unemployment benefits have run out, it will be a while before another round of stimulus checks gets to citizens and uncertainty remains the one constant.


A new RBC research report from Michael Eisen and the aerospace and defense team says what many experienced investors are well aware of: the outlook forward remains positive because defense especially will get funded by the government. The report noted this about the sector’s underperformance over the past three months:

Defense exposure continues to provide a more stable fundamental backdrop. Investor concerns regarding the outlook for defense budgets has weighed on the sector’s valuation, which we think has been overstated. The group has appreciated on average by 4% over the past 3 months, vs. +16% for the S&P 500. Earnings results from the Defense contractors have all held in much better than feared, delivering headline beats for all companies with a majority of sales to the end market. Book-to-bill ratios also held above 1x across the board, with the strongest backlog growth coming from space based programs. In contrast, the outlook for Commercial demand has turned more bleak as the spread of COVID-19 continues to trend in the wrong direction.

We screened the RBC coverage universe looking for mega-cap leaders that are rated Outperform, and four look like outstanding ideas for investors looking to gain a more defensive posture, literally and figuratively, for the rest of the year.

Boeing

This company has had a public relations nightmare due to the 737 Max issues. Boeing Co. (NYSE: BA) is the world’s leading aerospace company and the largest manufacturer of commercial jetliners and military aircraft combined. It is also one of the most valuable brands in the world.

The different segments in the company are Commercial Airplanes, Boeing Defense, Space & Security and Boeing Capital. The latter provides financial solutions facilitating sale and delivery of Boeing commercial and military aircraft, satellites and launch vehicles.

The analysts noted this:

CEO Dave Calhoun stated that the company is “prudently and proactively reviewing every aspect of our company.” This could result in the divestiture of business lines to sharpen the company’s focus and provide incremental capital to fund operations and future R&D.

While the macro environment is still highly uncertain, many on Wall Street believe Boeing can communicate greater visibility and confidence in all the key matters the company faces. Recertification test flights have begun, customers have had more time to make near-term and long-term fleet planning decisions, and Boeing secured $25 billion of additional liquidity with the May bond issuance.

The RBC price objective for the shares is $194, while the Wall Street consensus target is lower at $175.77. Boeing stock closed Thursday trading at $172.20.

General Dynamics

This company, like other major defense prime contractors, has had a solid year, and the balance of 2020 could be better. 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 eight-wheeled assault vehicle, medium-caliber munitions and gun systems, tactical and strategic mission systems.

Some Wall Street analysts were disappointed by quarterly results from the company’s information technology segment. Though most don’t view the segment’s struggles as a product of a structurally impaired business, some may begin to question that thesis. However, most continue to see value in the company’s Marine, Aerospace, Mission, and Land businesses and view the overall valuation as depressed.

General Dynamics stock investors receive a 2.95% dividend. RBC has a $164 price target, though the consensus estimate is up at $172.11. The last trade on Thursday hit the tape at $149.14.