Three Defense Plays For an Uncertain Market

Chances are you seen some of the big headlines surrounding the U.S. military and the intelligence community. But I don’t want to let this distract us from one of our nation’s most poignant holidays: Veteran’s Day. While yesterday was the official holiday—World War I ended on the 11th hour of the 11th day of the 11th month—schools and government offices are closed today in observance of the tradition.

And even if you are at work today like I am, I hope you take a moment to reflect on the sacrifices made by our armed forces to preserve the freedoms we enjoy today. In the meantime, I want to direct your attention to some of the largest private sector players that help support the U.S. military. Even though a new wave of defense cuts is scheduled for next year, we’re still seeing a number of aerospace and defense companies that have strong profit potential.

In particular, I consider these three companies to be some of the most exciting plays on this sector:

  1. Raytheon Co. (RTN) is a major American defense contractor who specializes in weapons and military electronics. Throughout the company’s 90-year history, Raytheon has served a wide base of public and private clients, oftentimes in conjunction with some of its biggest competitors.Over the past year, this Conservative stock has improved from a C-rated hold to an A-rated buy, and that’s mostly thanks to a meteoric rise in buying pressure. As such, shares advanced 21% during the past 12 months. But given this company’s strong fundamentals (especially its cash flow and return on equity), I expect further upside for this stock. With a 3.6% annual dividend yield (the second highest in the industry), RTN is a strong buy.
  2. TransDigm Group Inc. (TDG) is an aerospace and defense company with the highest margins in its industry—its operating margins of 43% are massively higher than its competitors. More than half of its revenue comes from aftermarket sales, and only about a quarter of its revenue is from military sales—a good thing considering the budget cuts hitting the government. 2012 has been a good year for this stock (also Conservative): It has maintained its A-rating for each of the past 12 months. As to be expected, buying pressure has held up during that time, so shares have soared 40%. This quarter TransDigm is headed towards 36% sales growth and 21% earnings growth this quarter—over seven times the industry average! And things look even better for full-year 2012, with estimates putting TransDigm at 41% sales growth and 50% earnings growth. So I also consider TDG a strong buy.
  3. TASER International Inc. (TASR) is a significantly smaller play than the first two, but its specialty—the taser electroshock gun—is sold in a wide range of markets, including military, law enforcement, private security and personal defense. The wide appeal of this product drives over $1.2 billion sales every year.

Interestingly enough, this company’s total grade has improved significantly over the past seven years. While TASR did improve in terms of buying pressure, the company firmed up its sales growth, earnings momentum and its track record of beating earnings estimates. So the company is now an industry leader in terms of top- and bottom-line growth, long-term growth rate and return on equity. And with analysts expecting 21% sales growth and 400% earnings growth this quarter, I expect further upside from this Moderately Aggressive stock.

And here’s my take on several of the largest aerospace and defense players going forward.

(To review, the Quantitative Grade indicates the current level of buying pressure for each stock—what I consider to be the most important factor in my stock grading system. Meanwhile, the Fundamental Grade is created by weighting the average of eight fundamental metrics, including sales growth, operating margin, earnings growth, earnings momentum, earnings surprises, analyst earnings revisions, cash flow and return on equity.)

Company Ticker Quantitative Grade Fundamental Grade Recommendation
Booz Allen Hamilton BAH A C Buy
General Dynamics Corp. GD D C Sell
Honeywell International HON C B Hold
Lockheed Martin Co. LMT A B Buy
The Boeing Company BA C B Hold

That’s all I have for today—stay tuned to this daily blog for the latest stock and market commentary as we draw closer to the end of 2012.


Louis Navellier

Louis Navellier

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