Russia’s invasion of Ukraine has rattled global stock markets, triggering a selloff. However, the ongoing armed conflict has also created a strong tailwind for certain pockets of the market, especially for companies in the aerospace and defence sectors.
The perception of a heightened threat to nations’ sovereignty and territorial integrity leads to larger defence allocations which drives revenue growth for leading arms producers.
Governments typically award multiyear contracts for arms purchase, maintenance and periodic upgrades. For that reason, defence contractors with highly specialized products and technical knowhow enjoy a near monopoly in a marketplace with high barriers to entry.
These three arms manufacturers are well positioned to benefit from the growing demand for weaponry and military technology as the U.S. and its NATO allies boost their defence in a multipolar world with Russia and China.
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Lockheed Martin Corp |
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Ticker |
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Current yield: |
2.74% |
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Price |
US$409.49 |
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Fair value: |
US$419 |
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Value |
Fairly valued |
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Moat |
Wide |
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Moat Trend |
Stable |
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Star rating |
*** |
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Data as of Feb 28, 2022 |
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The world’s largest defence contractor, Lockheed Martin (LMT) operates multiple businesses with the largest segment being Aeronautics, dominated by the massive F-35 program. Lockheed’s remaining segments comprise rotary & mission systems (mainly the Sikorsky helicopter business), missiles and fire control, and space systems(satellites).
Lockheed Martin's exposure to the F-35 program, hypersonic missiles, and the militarization of space is well aligned with areas of secular growth within the defence budget. “The allocation of the defence budget is a political process, which is inherently difficult to predict,” says a Morningstar equity report, noting that this favours “companies with tangible growth profiles through a steady stream of contract wins, ideally to contracts that are fulfilled over decades.”
Heightened geopolitical tensions between great powers are likely to spur spending despite a higher government debt burden. “Contractors will be able to continue growing despite a slowing macro environment due to sizable backlogs and the national defence strategy’s increased focus on modernization, and we think that defence budget growth is likely to return to its long-term trend,” asserts Morningstar equity analyst Burkett Huey, who recently raised the stock’s fair value from US$402 to US$419, prompted by strong fourth-quarter earnings.
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General Dynamics Corp |
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Ticker |
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Current yield: |
2.09% |
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Price |
US$227.98 |
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Fair value: |
US$201 |
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Value |
13% Premium |
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Moat |
Wide |
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Moat Trend |
Stable |
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Star rating |
** |
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Data as of Feb 28, 2022 |
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U.S. defence contractor, General Dynamics (GD) offers products and services in four segments: aerospace Gulfstream business jets), combat systems (land-based combat vehicles, such as the M1 Abrams tank), marine (nuclear-powered submarines), and technologies. The technologies segment contains two business units, an IT business that primarily serves the government market and a mission systems business that focuses on products that provide command, control, computers, intelligence, surveillance, and reconnaissance capabilities to the military.
“General Dynamic’s crown jewel of long-cycle contracts, the Columbia-class submarine, exemplifies this with planned procurement through 2042,” says a Morningstar equity report.
The expectation of a near term slowdown in defence spending may be due for a revision in light of the growing geopolitical unrest and military conflict. Either way, “contractors will be able to continue growing due to sizable backlogs [combined with the fact] that defence budget growth is likely to return,” says Huey, who recently raised the stock’s fair value from US$191 to US$201, prompted by strong fourth-quarter earnings.
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Raytheon Technologies Corp |
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Ticker |
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Current yield: |
2.08% |
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Price |
US$98.12 |
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Fair value: |
US$90 |
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Value |
Fairly valued |
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Moat |
Wide |
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Moat Trend |
Stable |
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Star rating |
*** |
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Data as of Feb 28, 2022 |
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Raytheon Technologies (RTX) is a diversified aerospace and defence industrial company resulting from the merger of United Technologies and Raytheon. The merged entity operates in four segments: Pratt & Whitney (engine manufacturer), Collins Aerospace (diversified aerospace supplier), integrated defence and missile systems; and intelligence, space and airborne systems.
The combined entity is fundamentally unique due to its relatively even balance between commercial aerospace and defence prime contracting, whereas most of its peers are heavily skewed one way or the other.
Raytheon is exposed to missiles, missile defence systems, space militarization, and IT services for the government. “We’re expecting that the military’s increased focus on defending against great powers conflict will drive material investment in each of these exposures, excluding government IT services,” says a Morningstar equity report.
Missile defence programs are a highly complex long-cycle product. These programs are predicated on shooting a high-velocity projectile with another projectile midair. “We expect continued investment in missile defence, as adversary states are actively developing hypersonic missiles that would penetrate current systems,” says Huey who recently nudged the stock’s fair value slightly from US$89 to US$90.
