In terms of stock returns, the last 12 months has been unimpressive for defense stocks. This has resulted in most names trading at attractive valuations. These companies have robust cash flows and a healthy dividend payout.
I therefore believe that it’s a good time to consider exposure to some quality names in the industry.
Geopolitical issues might have taken a back seat on a relative basis as the world struggles to cope with the novel coronavirus pandemic. However, countries will continue to ramp up defense spending and the long-term outlook for defense stocks remains bright.
As a matter of fact, global defense spending hit $1.9 trillion in fiscal year 2019. This was the highest percentage increase in spending since 2010.
So, let’s look at three quality defense stocks that are worth considering at current levels.
Defense Stocks to Buy: Lockheed Martin (LMT)
If there was one stock that I had to pick from the defense sector, it would be LMT stock. Lockheed Martin returned just 2.4% in the last one year and trades at an attractive price-earnings ratio of 15.2. Furthermore, the company offers an annual dividend of $9.60, which will attract income investors.
From a business perspective, Lockheed Martin reported an order backlog of $150.3 billion for the second quarter of 2020. This was the eighth consecutive quarter of record backlog for the company. A strong order backlog and healthy order inflow will ensure that cash flows remain strong and dividends sustain.
Lockheed Martin derives 73% of revenue from the U.S. government. International customers account for 27% of the total revenue. I believe that there is ample scope for backlog growth in international markets in the coming years. As an example, Europe’s defense spending is expected to surpass $300 billion by 2021.
Overall, Lockheed Martin is a cash flow machine and the stock is likely to trend higher as the order backlog swells. Additionally, a stock with a beta of 0.96 is worth considering for a conservative portfolio.
Northrop Grumman (NOC)
NOC stock is another defense name that is trading at an attractive P/E valuation of 13.6. With a strong cash flows, the company is also a quality dividend stock and has a current payout of $5.80 per share.
As of the first quarter, the company reported an order backlog of $64.2 billion. Further, for the quarter, the company reported net awards of $7.9 billion. Therefore, the order inflow has remained robust and the current backlog implies steady cash flows in the coming years.
Coming back to cash flows, the company expects free cash flow of $3.15 to $3.45 billion for the current year. The company’s top-line growth has been healthy in the space, mission and defense systems. If this growth sustains, higher FCF will translate into dividend growth and NOC stock upside.
Northrop Grumman also derives 85% of revenue from the United States with only 15% coming from international markets. One of the company’s objectives in the coming years is to strengthen the international business. In addition to this, the company’s capabilities in space, autonomous airborne system and hypersonic is likely to deliver growth.
Considering these factors, NOC stock is worth holding in the portfolio for stock appreciation as well as sustained dividends.
General Dynamics (GD)
With strong fundamentals, a healthy order backlog, attractive valuations and an attractive dividend payout, GD stock is worth considering from the defense stocks.
As of the first quarter, General Dynamics reported an order backlog of $85.7 billion. The company’s order backlog has increased by 24% on a year-on-year basis.
Clearly, backlog growth has been strong and this is likely to translate into sustained cash flows. Therefore, the current dividend payout of $4.40 is safe and can potentially increase if backlog growth remains strong.
General Dynamics’ order backlog has been stable across most segments in the last few quarters. However, in the marine segment, the company’s order backlog has increased from $27.4 billion in the first quarter of 2019 to $43.2 billion in 2020. The marine business can be a potential game changer in terms of growth. There are not many players in the defense industry globally that can build the nuclear-powered submarine.
Finally, if we look at the valuations, GD stock is trading at a P/E ratio of 13. The stock has been an underperformer having declined by 21% in the last one year. I would not be surprised if the stock delivers healthy returns in the coming quarters.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock-specific articles with focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.