What Cuts? 3 Defense Contractors Worth Considering

Defense_Stocks_Jets_Airforce_185.jpgThe political and economic conversation in Congress revolving around the “fiscal cliff” is fairly complicated both politically and economically, but it really comes down to two issues: taxes and spending.

With regard to the former, the Bush tax cuts will expire on Jan. 1, 2013, with all the ramifications it brings to both lower-, middle- and higher-income tax brackets.

With regard to the latter, the biggest hit will come at the expense of the U.S. defense budget, which will take mandatory billion-dollar hits across the board as part of the Budget Control Act of 2011’s “sequestration” requirement after a congressional “Supercommittee” (shockingly) couldn’t come to a budget agreement.

The January 1, 2013 deadline was just kicked down the road another six months beyond the government’s September 30, 2012 fiscal year, until March 2013, as congressional leaders managed to hammer out an (equally surprising) agreement to fund government operations through the election season and past this Congress’s lame-duck session.

Despite the change in date however, a lot of employees, not to mention congressional delegates and the current and potential President, are still looking down the barrel of a big problem.

Dramatic cuts to defense spending ($55 billion in 2013 alone and a projected $500 billion over 10 years) will slam a wide sector of the economy since defense contractors, smart people that they are, have spread so many pieces of their U.S. government business across so many states in the U.S.

The fact is that many defense contractors have already started to batten down the hatches, and for some of them, those cuts are actually starting to pay off in solid earnings results. Indeed, the industry is seeing valuations and dividend yields that make investors yearning for yield and income drool.

So, it’s worth taking a look at both those efforts and how cuts may effect shareholders in the future. Here are three big contractors that look ready to keep rolling.

Lockheed Martin (NYSE:LMT) is a global security and aerospace company that employs about 120,000 people worldwide and is principally engaged in the research, design, development, manufacture and integration of advanced technology systems. It’s net sales for 2011 were $46.5 billion, and in its most recent quarter Lockheed announced stellar earnings and revenue gains well above Street estimates.

The company managed to straddle the line on impending cuts, raising guidance on 2012 results, but warning about layoffs that could reach 100,000 employees over time if defense spending is slashed. Economies of scale (or wringing out excess costs) have helped boost profitability, and investors should have no doubt that layoffs could be a big part of the earnings per share equation.

But in the bigger picture, Lockheed Martin is a huge, sprawling company with a $29 billion market cap and a forward price-earnings ratio of only 11. It’s hard to be bearish on the stock, given the diversity in government programs. Plus, the company still has $4 billion in cash to weather the storm, and with a 4.5% dividend yield, investors have no reason to bail out.

General Dynamics (NYSE:GD) is an aerospace and and defense company that represents Virginia on the InvestorPlace Real America Index. Like the majority of big-time government contractors, it has a global footprint. And with revenues of $32 billion and 95,000 employees pumping out everything from combat vehicles to weapons and munitions, U.S. defense cuts might hurt but won’t destroy GD.

In fact, second-quarter earnings of $1.77 per share surpassed the Zacks Consensus Estimate of $1.74, although they came in lower than last year by 2 cents per share. And overall revenue was higher by 0.5% on strength in its Aerospace, Marine and Combat Systems groups. GD continues to buy back shares and pays out a steady 51-cent quarterly dividend. It provided cautious but positive 2012 guidance.

Order backlog is the problem, however, as the company has seen this number shrink by $5 billion over the past year, and slowdowns in contract deliveries are knotting up forecasts. What GD has not said, at least to date, is how many, if any, people it could lay off if the budget cuts are made. Stay tuned for that press release, and in the meantime enjoy a 3.3% dividend yield.

Northrop Grumman (NYSE:NOC) is well versed in the art of government contracting, offering its services as an integrated provider in aerospace, electronics, information and services. That’s a mouthful, but here’s what’s most important: NOC conducts most of its business both with the Pentagon and the intelligence community. So, you know, some pretty important stuff.

With just over $26 billion in revenues NOC doesn’t have quite the pull of LMT or GD, but each one of its four business segments is critical in aerospace (unmanned aircraft systems), electronics (F-16 scanned array sensors), IT (cybersecurity) and technical services (biometric capture for Homeland Security).

Quarterly revenue growth is slowing, however, and net income levels are growing, but ever so slowly. First-quarter margin remain relatively flat, though still high, at 12.5% compared with 12.7% during the first quarter of 2012.

Still, Northrop Grumman inhabits an important part of the defense network, and is trading near 52-week highs. It also pays a robust 3.3% dividend yield. NOC has yet to cry wolf over cuts, or provide any guidance (or warnings) on employee cuts. An investment here isn’t much of a stretch.

In fact, spending money in the defense industry is a pretty smart play, despite the dire warnings you hear from their CEOs and congressional mouthpieces.

Marc Bastow is an Assistant Editor at InvestorPlace.com. As of this writing he does not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2012/08/defense-contractors-under-fire-still-a-great-investment-gd-lmt-noc/.

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