There has been a sharp escalation in geo-political tensions in the recent past. This has impacted asset markets. With Russia ordering troops into Eastern Ukraine, it seems like tensions will prevail in the coming weeks. From an investment perspective, it makes sense to go overweight on low-beta stocks. Some of the examples include defense stocks and pharma stocks.
In particular, the current tensions will benefit defense stocks. If the tensions escalate further, defense companies are positioned to witness a boost in their order books. Also. If the tensions de-escalate, Europe will be looking at further increasing its defense spending. Most of the North Atlantic Treaty Organization (NATO) allies are already short of the annual defense spending target.
It’s also worth noting that even during the pandemic year (2020) defense spending increased on a year-on-year basis. This underscores the view that the defense sector is evergreen in nature.
With these factors in consideration, let’s talk about three defense stocks that are worth buying. I believe that these stocks are worth holding in the long-term portfolio.
Defense Stocks to Buy: Lockheed Martin (LMT)
LMT stock is possibly the top name to consider among defense stocks. Not just from a business perspective, but also considering the valuation. At a forward price-to-earnings-ratio of 15.38, the stock looks attractive. Additionally, LMT stock is a low-beta name with a forward dividend yield of 2.7%.
One reason to like Lockheed is the order backlog. As of December 2021, the company reported a backlog of $135 billion. This provides medium-term revenue and cash flow visibility.
For the current year, Lockheed expects sales of $66 billion and operating cash flow of $7.9 billion. It’s likely that OCF will remain robust and that will help in sustaining dividends. For 2022 and 2023, the company expects consolidated free cash flow of $12 billion.
Another reason to like LMT stock is the company’s gradual diversification of revenue. Lockheed has been increasingly working with NATO allies. This is likely to boost the international order backlog. An October 2020 article indicated that most NATO allies are still short of the defense target spending. With the recent escalation in tension in the region, it’s likely that Lockheed will benefit.
Rada Electronic (RADA)
I believe that RADA stock is a hidden-gem among defense stocks. The company is still at an early growth stage and the outlook seems promising.
As an overview, Rada is a manufacturer of defense electronic equipment. The company has focus on tactical radars with sales to 30 countries globally. Rada believes that the total addressable market for tactical radars is $6 billion.
It’s worth noting that Rada has reported revenue growth of 105% and 70% for 2020 and 2021 respectively. For the current year, the company is targeting revenue of $140 million. Further, over the next 3-4 years, revenue is likely to swell to $250 million.
In their guidance, Rada has also indicated that mergers and acquisitions are likely to be a part of the growth strategy. Therefore, revenue growth can accelerate more than expected through the inorganic route.
Another point to note is that Rada reported EBITDA margin of 13% in 2020. For the last financial year, EBITDA margin expanded to 23%. With sustained revenue growth, the company is positioned for further margin expansion and potentially robust cash flows.
Last year, Rada and Alpha Design Technologies established a joint venture in India. India is ramping-up defense spending with hostile neighbors. Growth can be robust for the company in emerging markets.
Defense Stocks to Buy: Northrop Grumman (NOC)
NOC stock has delivered returns of 48% in the last 12-months. However, at a forward P/E of 16.39, the stock looks attractive and has potential for further upside. NOC stock also has a current forward dividend yield of 1.53%.
For 2021, Northrop reported sales of $35.7 billion. On a year-on-year basis, organic sales growth was 3%. For the current year, the company has guided for sales of $36.4 billion (mid-range).
An important point to note is that for 2022, Northrop expects transaction-adjusted free cash flow of $2.65 billion. For the next two years, the FCF is likely to increase to $2.8 and $3.25 billion. This will give the company headroom for dividend growth and continued share repurchase.
Steady growth seems likely considering the company’s order backlog. As of December 2021, the total order backlog was $76 billion. This provides two-year revenue visibility. Importantly, the net order intake for 2021 was $32.1 billion. If the order intake remains robust, the company is well positioned for sustained growth in FCF.
It’s also worth noting that for 2021, the space systems segment reported sales of $10.6 billion. On a year-on-year basis, organic sales growth for the segment was 24%. While the divested business impacted growth, the outlooks is positive if the space segment growth sustains.
On the date of publication, Faisal Humayun did not hold (either directly or indirectly) any positions in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector.
