Let’s not mince words: This is a tough time to be a defense contractor. With the Pentagon staring down the barrel of nearly half a trillion dollars in cuts over the next decade (double that if “sequestration” cuts are triggered in January), those halcyon days of feasting at the federal trough are gone for the foreseeable future.
But don’t stick a fork in the defense sector just yet. Stable, diversified defense stocks will survive despite defense cuts — and many pay a healthy dividend to boot.
Despite the headwinds, top defense names are stable, mega-cap, average- to low-beta stocks that reliably pay out dividends at rates that beat 10-year Treasuries. But rather than buy now, I think it would be prudent to hold off on these stocks until after Thanksgiving, when the post-election dust has settled and bargains abound.
Boeing (NYSE:BA): Boeing reported stronger-than-expected third quarter earnings on Wednesday, largely on the soaring success of its commercial aircraft division. Earnings also rose in the Defense, Space and Security operations. BA reported third-quarter net income of $1.35 a share on a top line of about $20 billion; analysts had expected EPS of just $1.12 a share, although revenue met expectations.
With many of the crippling production delays of the 787 Dreamliner finally behind it, BA delivered 22 more jets in the third quarter than it did a year ago, yielding a whopping 28% revenue increase for that division. The company also raised its full-year 2012 EPS estimates to between $4.80 and $4.95, compared to earlier estimates of $4.40 to $4.60.
Boeing remains my top defense stock pick … in large part because of its non-defense business. BA booked 369 net commercial aircraft orders in the third quarter and has boosted production of the popular twin-engine 777 to 8.3 jets a month.
Obviously Boeing is still in the defense business, as the $2 billion C-17 sustainment contract awarded earlier this month illustrates. Still, a high-growth market opportunity for new and replacement commercial aircraft will help the company ride out some of the turbulence of leaner defense budgets — if it can keep production on schedule and pension costs in line. The stock has a forward P/E of about 13 and a current dividend yield of 2.4%.
Lockheed Martin (NYSE:LMT): Lockheed Martin announced Wednesday that its third-quarter earnings jumped by 11% to $2.21 a share on revenue of nearly $11.9 billion, beating expectations for EPS of $1.85 on close to $11.2 billion in revenue. Lockheed also boosted its 2012 earnings forecast to between $8.20 and $8.40 from earlier estimates of $7.90 to $8.10.
LMT is the largest pure defense play, and its high-profile programs include the problem-plagued F-35 Lightning Joint Strike Fighter. The Pentagon will delay production of 179 of the jets over the next five years due to budget cuts, but Japan placed an order for 42 of the F-35s and is working with Mitsubishi Heavy Industries to produce some of the jets locally.
One nagging concern: Sales are down at Lockheed’s Information Systems & Global Solutions unit, which provides IT services — including cybersecurity — to the Pentagon and civilian federal agencies. The company said that its revenue next year would drop in the “low single-digit rate” from current levels. Still, the federal government’s “cloud first” doctrine, requiring agencies to move applications to virtualized servers to save money and boost efficiency, could help LMT long term.
LMT hit a new 52-week high on Wednesday. The stock has a forward P/E of 11 and its current dividend yield is a thriller at 5%.
Northrop Grumman (NYSE:NOC): What makes a nearly 12% year-over-year drop in quarterly earnings not quite as bad as it seems? The fact that Northrop Grumman’s third-quarter earnings of $1.82 a share still beat the Street’s expectations of an EPS of $1.69. However, sales dipped about 5% year-over-year to $6.27 billion; analysts had expected $6.34 billion.
NOC’s Global Hawk drone program may be bracing for Pentagon cuts, but the company is finding a strong emerging opportunity for commercial drones. Increased demand for commercial drones boosted revenues in NOC’s Aerospace unit by 5% in the third quarter.
One notable bright spot: NOC has done a great job of generating cash. Year-to-date, the company has generated free cash flow of $1.4 billion — nearly 100% of net income — and that cash has supported share repurchases. NOC repurchased about 4.4 million shares of stock for $290 million in the quarter.
NOC just set a new 52-week high on Oct. 18, but it will probably become a bit more affordable after the election. NOC has a forward P/E of 10 and a current dividend yield of 3.2%.
United Technologies (NYSE:UTX): United Technologies’ third-quarter earnings also beat the Street on Tuesday, although profit was down 6% from the same quarter last year. UTX earned $1.37 a share on a top line of $15.04 billion; analysts had expected an EPS of $1.18 on $15.51 billion in revenue. Sales rose 5.7%, but costs rose by more than 7%.
The top-performing unit was the new UTC Aerospace Systems, which includes the company’s summer acquisition of Goodrich and existing Hamilton Sunstrand business. Revenue doubled in the quarter, while profit surged by one-third. It doesn’t hurt that the restructured aerospace division has a new home in North Carolina — a “right-to-work” state with lower labor costs.
And make no mistake: Cost-cutting will be a big component of UTX’s strategy to drive profits. CFO Greg Hayes told analysts on Tuesday that restructuring in its Sikorsky Aircraft, Pratt & Whitney and UTC Aerospace divisions could save as much as $600 million.
The stock has a forward P/E of 13, which is a little high in this sector. Its current dividend yield is 2.8%.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.