The ongoing conflict in Ukraine, Israel’s offensive in the West Bank, North Korea calling a US movie an act of war, the latest in Iran, and US troops going back to Iraq suggest there may finally be upside to a defense budget that has experienced nothing but pressure since peak spending at $691 billion in 2010 (see grey bar in image below, from left to right).
Image Source: US DoD Fiscal Year 2015 Budget Request
With the markets making new highs seemingly every week, bargains have become more difficult to find. We point members to ideas in the Best Ideas portfolio and Dividend Growth portfolio, but an increasingly more uncertain geopolitical backdrop–where defense spending upside is growing more and more likely–may make exposure to the resilient, yet politically-cyclical, defense industry attractive. The largest contractors are a bit pricey (their respective price-to-fair values are above 1) at present, but we note their premium valuations are not out of line with those of constituents in other industries. Still, we generally don’t pay above fair value for anything, so patience is always a good strategy when it comes to picking entry points. The largest defense contractors also have solid dividend growth profiles, with Lockheed Martin sporting the largest yield.
| Company (symb) | Share Price | FV | Price / Fair Value | Dividend per Share |
Div Yld |
Div Cushion | Backlog (Q2) | Backlog growth |
| FLIR Systems (FLIR) | $34.63 | $30.00 | 1.15 | $0.40 | 1.2% | 4.5 | $548m (12mo’s) | up 12% since end of 2013 |
| General Dynamics (GD) | $121.14 | $98.00 | 1.24 | $2.48 | 2.0% | 3.0 | $71.1 billion | up 27% sequentially |
| Lockheed Martin (LMT) | $170.04 | $142.00 | 1.20 | $5.32 | 3.1% | 1.8 | $77.8 billion | was $82.6 billion (end of 2013) |
| Northrop Grumman (NOC) | $127.56 | $121.00 | 1.05 | $2.80 | 2.2% | 3.3 | $35.6 billion | was $37 billion (end of 2013) |
| Raytheon (RTN) | $92.07 | $91.00 | 1.01 | $2.42 | 2.6% | 2.8 | $33 billion | was $33.7 billion (end of 2013) |
| Note: Boeing’s performance is excluded given the aerospace giant’s growing commercial exposure. | ||||||||
Let’s take a look at the group’s second-quarter reports, and wrap things up at the end.
FLIR Systems (FLIR)
WILSONVILLE, Ore., July 24, 2014 (GLOBE NEWSWIRE) — FLIR Systems, Inc. (Nasdaq:FLIR) today announced financial results for the second quarter ended June 30, 2014. Revenue was $369.4 million, down 5% compared to second quarter 2013 revenue of $389.3 million. Operating income in the second quarter was $59.4 million, compared to $70.3 million in the second quarter of 2013, and was impacted by $3.5 million in pretax charges related to previously-announced restructuring initiatives. Second quarter 2014 net income was $44.8 million, or $0.31 per diluted share, compared with net income of $50.2 million, or $0.35 per diluted share in the second quarter a year ago. The net after tax impact of the restructuring charges in the second quarter was approximately $2.7 million, or $0.02 per diluted share. Cash provided by operations in the second quarter was $70.6 million. To continue reading >>>
General Dynamics (GD)
FALLS CHURCH, Va. – General Dynamics (NYSE: GD) today reported 2014 second-quarter earnings from continuing operations of $646 million, or $1.88 per share on a diluted basis, compared to second-quarter earnings from continuing operations in 2013 of $640 million, or $1.81 per diluted share. Second-quarter 2014 revenues were $7.5 billion. There is a charge in the quarter of $105 million in discontinued operations for the sale of a business within Combat Systems, which results in net earnings for the second quarter of $541 million, or $1.58 fully diluted earnings per share. To continue reading >>>
Lockheed Martin (LMT)
BETHESDA, Md., July 22, 2014 – Lockheed Martin Corporation [NYSE: LMT] today reported second quarter 2014 net sales of $11.3 billion, compared to $11.4 billion in the second quarter of 2013. Net earnings in the second quarter of 2014 were $889 million, or $2.76 per diluted share, compared to $859 million, or $2.64 per diluted share, in the second quarter of 2013. Cash from operations in the second quarter of 2014 was $977 million, compared to cash from operations of $623 million in the second quarter of 2013. To continue reading >>>
Northop Grumman (NOC)
FALLS CHURCH, Va., July 23, 2014 /PRNewswire/ — Northrop Grumman Corporation (NYSE: NOC) reported second quarter 2014 net earnings increased 5 percent to $511 million, or $2.37 per diluted share, compared to $488 million, or $2.05 per diluted share, in the second quarter of 2013. Second quarter 2013 earnings included a $30 million charge principally related to “make-whole” premiums paid to redeem $850 million of senior notes, which reduced net earnings by $20 million, or $0.08 per share. To continue reading >>>
Raytheon (RTN)
WALTHAM, Mass., July 24, 2014 /PRNewswire/ — Raytheon Company (NYSE: RTN) announced second quarter 2014 EPS from continuing operations of $1.59 compared to $1.50 in the second quarter 2013. Second quarter 2014 Adjusted EPS1 was $1.41 per diluted share compared to $1.64 per diluted share in the second quarter 2013. Second quarter 2014 Adjusted EPS1 excluded a favorable FAS/CAS Adjustment of $0.18, compared with an unfavorable FAS/CAS Adjustment of $0.14 in the second quarter 2013. Net sales for the second quarter 2014 were $5.7 billion compared to $6.1 billion in the second quarter 2013. To continue reading >>>
Wrapping Things Up
We continue to be comfortable with exposure to commercial aerospace, which is lumped into the aerospace and defense (A&D) industry, but pure defense contracts are growing more interesting. The large defense contractors may be more appropriate for dividend growth investors, given their robust payouts, but we think there could be upside potential to our valuations should defense spending accelerate in light of rising geopolitical tensions. Though we’re not rushing to add exposure at the moment, Lockheed Martin sports the highest dividend yield and the highest nominal backlog of unfulfilled orders among the group. We’re keeping a close eye on opportunities across the defense spectrum.
Aerospace & Defense – Prime: BA, FLIR, GD, LLL, LMT, NOC, RTN