Defense stocks have outperformed the stock market since the beginning of the year, but things have really heated up over the war in Ukraine. The iShares U.S. Aerospace & Defense ETF (BATS:ITA), one of the largest defense proxies, advanced 2.01% year-to-date to $105.84 per share, handily beating the SPDR S&P 500 Trust ETF (NYSEARCA:SPY), which is down 12.07% YTD.
Interest in defense stocks has naturally soared over the past few weeks. More and more investors are pricing in possible growth in military spending in the Western world, which will support defense stocks. In fact, Germany has already committed to increasing defense expenses by $100 billion in response to Russia’s invasion of Ukraine.
After decades of underinvesting in the defense sector, Germany’s historic policy shift might unveil a new spending era in Europe’s defense sector. Italy recently followed suit and other European countries will likely join the effort in the next weeks. Despite reluctance not too long ago, most European NATO members are now looking to permanently lift defense funding above the 2% GDP target.
In this context, let’s look at 8 major defense stocks and see how they performed during times of war:
- BWX Technologies (NYSE:BWXT)
- L3Harris Technologies (NYSE:LHX)
- Lockheed Martin (NYSE:LMT)
- Northrop Grumman (NYSE:NOC)
- Raytheon Technologies (NYSE:RTX)
- Thales (OTCMKTS:THLEF)
- BAE Systems (OTCMKTS:BAESY)
- Leonardo (OTCMKTS:FINMY)
In the U.S, defense budgets are also projected to get a push in response to recent developments in Eastern Europe. Defense expenditures should rise from around 2.8% to a range of between 3.5% and 4%, providing additional upside to the defense industry.
How Do Defense Stocks Perform During War?
Most defense stocks have significantly outperformed the stock market during periods of war.
During the 20 years of the war in Afghanistan LHX, NOC, LMT and RTX stocks respectively gained 1399%, 866%, 800% and 509%, whereas the SPY advanced only 297% from October 2001 to August 2021. The other stocks on our defense panel, namely BAESY, THLEF and BWXT posted a similar performance to the SPY over the period, but FINMY extensively underperformed the market.
Meanwhile, during the American-led intervention in the Syrian civil war, an ongoing war that started in September 2014, the performance of defense stocks was less impressive. LHX, NOC, RWXT, LMT and THLEF beat the broader market, whereas RTX, BEASY and FINMY’s performance since the beginning of the Syrian conflict has lagged the SPY.
Some of these stocks posted slower performance than the SPY during this war, yet most defense stocks have historically outpaced the broader market. Recurrent and massive government spending in defense capabilities provides good order book visibility. This stability is appreciated by market participants, explaining the good performance of the defense stocks.
BWX Technologies (BWXT)
BWX Technologies manufactures and supplies nuclear components and technologies for submarines and carriers.
BWXT shares have advanced reasonably year-to-date, up 8.39% to $52.60 per share. The company has similarly reasonable fundamentals. Net margins are forecast to reach 14.4% in 2021, before slowing to 12.9% in 2022. Revenue growth flattened in 2021 but is expected to rebound slightly in 2022, up 3.9% to $2.2 billion.
BWX Technologies has a healthy balance sheet and is expected to increase free cash flow robustly in 2022, up 28.8% to $966 million. The nuclear component specialist has a net debt of $1.14 billion at the end of 2021, representing a leverage ratio of 2.75x. Yet analysts are expecting that it will transition to a net cash position of $1.14 billion in 2022, a compelling catalyst for investors looking to invest in defense stocks.
The stock trades at attractive valuation metrics, with a forward P/E of 16.9x and a 2022 expected EV/EBITDA of 8.48x. The consensus of analysts has a twelve-month price target of $63 per share, representing an upside of 19.77%.
L3Harris Technologies (LHX)
LHX stock designs and manufactures communication equipment for the military aerospace industry. The company has been impacted in the recent quarter by supply chain disruption, but international demand for the F-35 fighter jet program should support LHX in the future.
LHX stock delivered a strong performance since the beginning of the year, as shares surged 18.16% to $250 per share. The defense stock delivered a double-digit profit margin of 10.4% in 2021 and analysts are forecasting that will advance to 12.2% this year. LHX’s top-line should decrease by 1.3% to $17.5 billion in 2022, before rebounding by 4.9% to $18.43 billion.
While this might weigh on the company’s stock in the short term, LHX is expected to reduce net debt in 2022 to $5.73 billion, down 6.2% year-on-year. This reduction delivers a tolerable leverage ratio of only 1.5x.
The rapid year-to-date appreciation of LHX shares has stretched the valuation of the defense stock, as it is now exchanging at 2022e P/E of 22.4x and forward EV/EBITDA of 14.1x. The upside is limited however, according to Wall Street analysts, with an average target price of $264.36 per share corresponding to just shy of 6% growth from today’s close.
Lockheed Martin (LMT)
LMT stock supplies aeronautic, submarine and aerospace systems, primarily to government organizations.
Shares of this defense stock surged 23.9% to $439.4 per share since January 2021, posting one of the best performances of the industry after announcing a deal to sell 12 C-130J-30 Super Hercules planes to Egypt.
LMT’s net margin lagged the defense industry in 2021, with profitability reaching 9.42%, but that’s predicted to increase to 10.8% this year. On the other hand, revenue growth should decrease slightly in 2022, down 1.4% to $66.1 billion, but will rebound 2.3% in 2023 to $67.6 billion.
In terms of LMT’s balance sheet, net debt is estimated to expand 10% to $8.8 billion this year. Yet the company’s leverage ratio of just 0.89x remains manageable for a defense stock with a market capitalization of $122.1 billion.
LMT stock is currently changing hands at a forward P/E of 16.5x and EV/EBITDA of 12.8x, with a dividend yield of 2.6%. According to the consensus of analysts, there is no material upside on LMT, given that the target price of $445.77 per share is close to its trading price.
Northrop Grumman (NOC)
NOC stock is one of the largest American weapons and military technology producers.
Northrop has gained 13.17% YTD to $436.30 per share. The company has one of the best defense portfolios in the industry. The military stock delivered profit margins of 19.6% in 2021, but it is expected to decline to 10.5% in 2022. Net sales withdrew 3.1% in 2021 to $35.6 billion, but the consensus forecast a slim appreciation this year, up 2.6% to $36.5 billion.
NOC is well-capitalized despite net debt forecast to rise 2.9% to $9.5 billion in 2021. This confers a leverage ratio of 1.96x, a tolerable level for this defense stock giant.
With the rapid advance of NOC stock, the company offers a 17.6x 2022e P/E ratio and trades at 16x forward EV/EBITDA. NOC also delivers a dividend yield of 1.56% in 2022 and the average target price for Northrop in the next twelve months stands at $453.86, a 4.02% change compared to its current price.
Raytheon Technologies (RTX)
RTX stock is one of the world’s leading aeronautic and defense groups. The company merged with United Technologies in 2020, creating a defense behemoth, with diversified exposure to the defense universe.
Shares of Raytheon have performed well year-to-date, rising 11.44% to $96.92 per share. Profit margin established at only 6% in 2021. Going forward, RTX’s yearly profitability is projected to reach 8.69% in 2022 and 10.4% in 2023.
Raytheon’s net debt is expected to slowly increase this year, up 2.1% to $24.1 billion, offering leverage of 1.93x, standing somewhat above industry peers.
RTX stock is currently trading at a forward P/E of 24.4x and 13.4x EV/EBITDA, providing a moderate dividend yield of 2.17% per year. Analysts are forecasting a yearly price target of $108.17 per share, corresponding to an upside of 11.61%
THLEF stock is a France-based company supplying solutions to the aerospace, transport and defense industry throughout the world.
Thales shares surged 38.08% year-to-date to $118.75 per share over increasing military spending in Europe.
THLEF’s forward-looking growth prospects are stronger than American peers, but net margins are lower, with 6.73% in 2021 and 7.08% in 2022. On the other side, after decreasing 4.7% to $18.3 billion in 2021, THLEF’s top-line is forecasted to grow healthily in 2022, up 6.3% year-on-year to $18.95 billion.
The company’s free cash flow is predicted to decrease steeply in 2022, down 34.2% to €1.62 billion. Nevertheless, THLEF is expected to shift to a net cash position of $330m this year, compared to net debt of $875 million in 2021.
THLEF exchanges at 19.8x 2022e P/E and 8.59x forward EV/EBITDA. The mean target price of Wall Street Analysts is $115.50 per share, representing a downside of 2.73% change from today’s price.
BAE Systems (BAESY)
BAESY stock is an international defense, aerospace and security company, supplying a broad range of products and services for air, land and naval forces.
BAE has posted a robust year-to-date performance, with the stock soaring 27.24% to $38.10 per share. The company’s profit margins established at 8.25% in 2021 and are expected to decline to 6.74% in 2022. Net sales grew modestly last year, posting an increase of only 2.1% to $28.1 billion, but are esteemed to accelerate 4% in 2022 to $29 billion.
BAESY’s balance sheet is expected to improve significantly, as net debt is forecast to decline 17.3% year-on-year to $2.77 billion this year and 33.4% to $1.84 billion in 2023, representing leverage of only 0.46x.
The defense specialist is currently trading at a forward P/E of 15.6x and EV/EBITDA of 8.42x. The average target price of BAESY in the next twelve months is $37.85 per share, corresponding to a downside of 0.65%.
FINMY is an Italian-based defense contractor and one of the leading aerospace defense system companies in Europe.
FINMY’s shares surged 36.42% to $4.88 per share since the beginning of the year, posting one of the best performances of the industry. However, the company’s profit margin of 3.68% in 2021 and expected net margins of 4.51% in 2022 are the lowest of our defense stocks. Nevertheless, revenue is projected to advance by 5.3% in 2022 to $16.3 billion and 3.3% to $16.7 billion in 2023.
Besides, the company is well-capitalized and analysts are expecting Leonardo’s net debt to decline in the next two years, down 6.2% this year to $6.2 billion and to decrease 5.7% to $5.9 billion in 2023.
In terms of valuation metrics, FINMY stock trades at cheap ratios, posting a 2022e P/E ratio of just 7.22x and EV/EBITDA of 5.04x.
On the date of publication, Cristian Docan did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Cristian Docan, a contributor for InvestorPlace.com, has been writing stock market-related articles for Seeking Alpha, Stocknews and Wealthpop since 2017. He takes a fundamental and technical approach in evaluating stocks for readers, focusing on momentum investing and macro-driven strategies.