This might seem like hindsight, which is understandable. And following industry trends isn’t always profitable. But the big danger is timing. Sometimes, momentum can trump underlying fundamentals.
Sequestration
The sequester was put in place so Democrats and Republicans would have to agree on fiscal issues. But all it really did was force budget cuts. Now, instead of eliminating needless and outdated programs, we’re stuck with budget cuts that will affect the military, education system, medical research, and more.
Defense Secretary Chuck Hagel seems to be very concerned. In his opinion, adding $500 billion in cuts to the $487 billion in cuts that are already in progress will not be in our country’s best interest. His dilemma is that he must either go with a smaller force and higher-end technology, or a larger force and lower-end technology. This is the epitome of a catch-22, and it’s perhaps one of the most important catch-22s that has ever existed.
The big player
Lockheed Martin Corporation (NYSE:LMT) is the largest defense contractor in the world. It has been a stalwart over the past decade. Revenue has improved over the past three years and the company is very profitable.
Luckily (or deservingly) for Lockheed Martin Corporation (NYSE:LMT), the Pentagon is likely to maintain strong ties despite impending cuts. However, Lockheed Martin will still take a hit, and it’s laying off employees in preparation for the incoming storm.
Lockheed Martin Corporation (NYSE:LMT) is led by a strong and wise upper management. Therefore, this is a company that might look for ways to add revenue streams outside of its normal dealings in order to make up for potential revenue losses due to government budget cuts.
On the other hand, Lockheed Martin Corporation (NYSE:LMT) owns a debt-to-equity ratio of 8.85, which is astronomically high. As long as the growth is there, this isn’t a major concern, but with government budget cuts in play, this could lead to trouble.
Good news for Northrop Grumman
Lockheed Martin Corporation (NYSE:LMT) recently chose Northrop Grumman Corporation (NYSE:NOC) over Raytheon Company (NYSE:RTN) for AESA radar upgrades on F-16 fighter jets in the U.S. and Taiwan. This was a big win for Northrop Grumman Corporation (NYSE:NOC), especially since South Korea opted for Raytheon Company (NYSE:RTN) for the same service earlier this year.
Northrop Grumman Corporation (NYSE:NOC) has seen revenue decline over the past two years, but it has made strategic moves to improve the bottom line. The share count has been reduced, margins have expanded, and the focus has been on the most profitable contracts. The big concern here is a decline in backlog, which is directly related to government budget cuts. Basically its main customer is less likely to commit than in the past.
Whatever it takes
Raytheon Company (NYSE:RTN) has also seen revenue decline over the past two years, but it’s not going to let industry trends stand in its way. If it won’t grow organically, then it will grow inorganically through acquisitions. Its latest purchase was Visual Analytics, a data analytics company. This fits Raytheon well, as it focuses on battlefield strategy via information and analysis.
That said, perhaps Raytheon Company (NYSE:RTN) doesn’t need any help. It recently beat earnings and upped its full-year guidance. For this year, revenue is now expected to come in at $23.5 billion to $23.7 billion versus a prior expectation of $23.2 billion to $23.5 billion. Adjusted EPS is expected to come in at $6.00 to $6.10 versus a prior expectation of $5.75 to $5.90.
Raytheon Company (NYSE:RTN) consistently buys back shares, it currently yields 3.10%, and it has been a consistent performer through the years. But its all-time stock performance doesn’t come close to that of Lockheed Martin Corporation (NYSE:LMT) or Northrop Grumman Corporation (NYSE:NOC). Perhaps that will change.
Conclusion
Lockheed Martin and Northrop Grumman have been neck-and-neck for decades when it comes to stock appreciation. And both companies offer generous dividends. At the moment, Lockheed Martin yields 3.80%, and Northrop Grumman Corporation (NYSE:NOC) yields 2.70%. However, Lockheed Martin is highly leveraged, whereas Northrop Grumman sports a healthy debt-to-equity ratio of 0.54. Therefore, Northrop Grumman is likely to better weather an economic storm.
While nobody can predict the future, the most likely scenario is that all three stocks continue to rise. However, this is an industry just like any other, and when nearly $1 trillion is pulled out of that industry, it’s going to hurt. The good news is that if any of these stocks get slammed, they’re resilient and important enough that it should present an excellent buying opportunity.
The article Is It Time to Bet on Defense? originally appeared on Fool.com and is written by Dan Moskowitz.
Dan Moskowitz has no position in any stocks mentioned. The Motley Fool owns shares of Lockheed Martin, Northrop Grumman, and Raytheon Company. Dan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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