Since the 2016 election, defense stocks have been on fire.
General Dynamics Corp (NYSE:GD) and Lockheed Martin Corp (NYSE:LMT) are both up over 20%. The laggard has been Northrop Grumman Corp (NYSE:NOC). That began to change on September 18, when the company announced it would buy Orbital ATK Inc (NYSE:OA) for $7.8 billion in cash.
In the five trading days since the deal was announced, NOC stock is up $15 per share, adding $2.6 billion to the company’s market cap.
While the deal should be accretive, thanks to cheap debt, something more than optimism over military spending is powering the stock forward.
The administration request of $539 billion in spending — plus $60 billion more for ongoing wars in Syria, Iraq and Afghanistan — was increased another $37 billion by Congress, on a bipartisan vote. Even before this budget, the U.S. represented one-third of the globe’s military spending.
Defense has been a very good business to be in.
Where Will All That Money Go?
The assumption among analysts is that the budget will include plenty of rockets, with the U.S. nuclear arsenal needing regular upgrades and the threat of war increasing.
NOC is more into what the President calls “the cyber.” Many of its contracts are for things like radar and navigation gear. The company has a large cybersecurity unit which, according to an article at Xconomy.com, it is in the process of expanding. The company is well-positioned to get its share of the new defense spending.
In the meantime, Northrop Grumman is still trying to extricate itself from a contract to operate computer systems for the state of Virginia, seemingly due to the demands it’s putting on NOC resources better spent on the U.S. defense contract.
What investors should be focusing on isn’t rockets or cybersecurity, however, but Northrop’s plane business. The company is producing over 100 B-21 bombers, estimated to cost $550 million each; the total of this contract alone is worth more than double the company’s annual revenues. And a generous Congress all but assures that cash will keep flowing.
Seen strictly through its finances, NOC is a boring company. Its 2016 revenue was slightly less than that of 2013. Its 2017 should be only a half-billion dollars more, on a $24 billion base. Profits, however, have been rising steadily, along with the dividend, which is now $1 per share.
Those who bought into NOC stock five years ago have seen their payout nearly double, while the shares themselves are up a whopping 321%. The value of the shares was rising faster during the Obama Administration than they have since.
Military contracting is like that. Big contractors like NOC can expect that 10 cents of every dollar that comes in hits the net income line, despite regular stories about how that’s threatened by this-or-that contracting dispute. Such disputes, and politics in general, aren’t reflected in the bottom line, which keeps growing steadily with revenue, whether Democrats or Republicans are in power.
This is why eight of the 21 analysts following NOC still have it on their buy lists, despite the spectacular five-year run-up in the stock price. Military contracting is a license to print money.
The Bottom Line
The best thing about the Orbital deal is that it is essentially a bolt-on, in that it will have little impact on the main company’s operations. This will make it relatively easy to integrate and profit from.
The minimal risk profile, the growth in the military budget, and the bolt-on nature of the Orbital acquisition are all why buyers have been rushing toward NOC shares over the last week and why, as a result, the shares are catching up to the growth of the group.
Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at firstname.lastname@example.org or follow him on Twitter at @danablankenhorn. As of this writing, he owned no shares in companies mentioned in this story.