When I hear investors, analysts and pundits talking about defense stocks the discussion inevitably turns towards the subject of the budget and the likelihood of defense cuts. That’s exactly the wrong discussion to have, in my opinion.
While we no longer have multiple conflicts involving hundreds of thousands of troops ramping up, the budget money is still being spent in certain segments of the budget and these amounts will grow going forward.
What we need to be talking about is the direction of spending in the budget to determine which defense stocks we should consider.
All it takes is a look at the headlines to realize that we cannot afford to move forward with certain segments of the budget. There are still numerous hot spots around the globe that have the potential to expand in the years ahead.
The Mideast has always been and always will be a source of conflict and I think we can expect that to continue. Russia’s President Vladimir Putin will probably continue to be an aggressor in that region of the world and China and Japan are becoming increasingly hostile toward one another.
Add to that terrorist threats and cyber-attacks and there are some companies that are going to see a continued floor of government dollars.
Think Small With Defense Stocks
I favor the smaller defense contractors right now and my favorite defense stocks is Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS). It is a smaller company but has exposure to some big markets in the defense sector.
KTOS is involved in electronic warfare programs, unmanned vehicles (drones), missile defense and cyber-security. It also works on what is known as critical infrastructure defense programs to keep things such as the electrical grid and major infrastructure centers — airports and military bases — safe from attack.
Business is pretty good right now for KTOS. In the fourth quarter alone, Kratos had new contract awards and bookings of $320 million, generated a book-to-bill ratio of 1.4 to 1.0, and the company’s funded backlog increased $129 million, up to $662 million with the total backlog increasing to $1.1 billion.
So far this year, KTOS has picked up an additional $110 million of contract awards. Kratos is a great example of a defense company in the right place at the right time. It should continue to earn contract awards and grow both the top and bottom line.
CPI Aerostructures, Inc. (NYSEMKT:CVU) is another defense stock that I think is an attractive defense stock in the current environment. The stock took a hit last year when the A10 program was cancelled by the Pentagon but it has recovered and is involved in some projects that will see continued defense spending in the years ahead.
CVU makes structural assemblies for fixed-wing aircraft, helicopters and airborne intelligence surveillance and reconnaissance (drones) for both the military and commercial aircraft manufacturers. The company just confirmed 2015 guidance that should be a record year in terms of revenues. The backlog at year-end was $403.7 million, with $148.9 million for commercial aerospace contracts.
Recent contract awards involve working on projects like the E-2D Advanced Hawkeye, the F-16 Falcon and the T-38C Talon Trainer. On the commercial side, CVU is working on the new aircraft from companies like Gulfstream International Group (OTCMKTS:GIGIQ), Honda Aircraft Company and Sikorsky, the subsidary of United Technologies Corporation (NYSE:UTX).
The commercial business is growing and CVU should continue to see military contract awards for new aircraft going forward. It is also a defense stock that in the right place at the right time.
There is a feeling that cutbacks in the defense budget will be bad across the board for defense stocks — but that’s not the case. The trick is to figure out which way the money will flow and find those defense stocks that are in place to collect their share of the funds.
