Military

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

U.S. Navy / Getty Images

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 Amazon.com 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%.

General Dynamics Corp. (NYSE: GD) posted 2018 defense revenues of $24.06 billion, representing 66% of total annual revenues. Among the company’s best-known armaments are the Abrams tank, the Stryker combat vehicle and the nation’s nuclear-powered submarine fleet. The consensus price target is $206.28, and the shares closed at $178.33 on Friday, for an implied upside of about 15.5%. General Dynamics stock has added about 13.5% so far this year.

BAE Systems is the U.S. subsidiary of BAE Systems PLC, a London-traded defense firm that sold $22.48 billion in defense systems last year for 91% of the company’s total for 2018. BAE specializes in electronic systems, cybersecurity and armored systems, among other things. The company’s stock is up more than 20% for the year to date, and at Friday’s closing price of 570.80 pence, the implied upside on the stock is 14.3% based on a price target of 652.67 pence.

United Technologies Corp. (NYSE: UTX) posted $9.31 billion in 2018 defense revenues, an amount equal to 14% of total sales for the year. Its merger with Raytheon is expected to close in the first half of 2020. The newly named Raytheon Technologies will manufacture Pratt & Whitney jet engines, and its Rockwell Collins division, which UTC acquired last year for $30 billion, is a large supplier of aerospace parts. On its own in 2018, UTC stock has added about 38% this year. The consensus price target of $160.71 implies an upside of 7.5% to Friday’s closing price of $149.49.

L3Harris Technologies Inc. (NYSE: LHX) is the result of a merger of equals between L3 Communications and Harris that closed last July. L3’s defense revenues in 2018 totaled $8.25 billion, while Harris rang up $4.60 billion in defense sales. Some 81% of L3’s total annual revenues were defense-based, while Harris’s defense sales accounted for 72% of all 2018 revenues. L3Harris stock closed at $199.99 on Friday, and the stock has a price target of $244.76, implying an upside of 22.4%.

Huntington Ingalls Industries Inc. (NYSE: HII) posted defense revenues of $7.77 billion in 2018, which accounted for 95% of total annual sales. The company launched the third of an order for four new U.S.nuclear-powered aircraft carriers earlier this month. Each costs about $13 billion, and all four are expected to be finished by 2027. The company’s stock has gained about 32% so far this year, and shares closed at $254.11 on Thursday. The price target of $267.62 implies an upside of 5.3%.

Leidos Holdings Inc. (NYSE: LDOS) had defense sales of $5.38 billion in 2018, representing 53% of the firm’s total revenues for the year. Last week, the company announced that it has agreed to acquire privately held Dynetics for $1.65 billion in cash. Dynetics brings technology products to the larger company that are focused on providing services to government agencies. The deal is expected to close in the first quarter of 2020. Leidos shares have added a whopping 88.3% so far in 2019, and the stock closed at $98.01 on Friday. Based on a price target of $95.83, the company may be overvalued.

These 10 firms represent nearly half of the top 21 defense firms (measured by revenues) in the world. The five largest defense firms in the world (excluding Chinese companies) are also the five largest U.S. defense firms, according to a recent report from the Stockholm International Peace Research Institute (SIPRI).  In the Defense News ranking, three of 2018’s top 10 are Chinese firms, including Aviation Industry Corporation of China, which edges out General Dynamics to rank fifth, with total defense sales of $24.9 billion (just 38% of the company’s total sales for the year).

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