Increased defense spending by the U.S. and several other countries has improved the outlook for companies that provide everything from information technology to consulting to military equipment in the name of national defense.
With the recent terrorist attacks in California, Paris, Beirut and Mali, it’s likely the U.S. and other countries that are potential targets of the Islamic State and other terrorist organizations will be increasing defense spending.
Companies that provide information technology, including Science Applications International Corp. (ticker: SAIC), will benefit, as will those that provide consulting services, such as Booz Allen Hamilton Holding Corp. (BAH), analysts say.
“The industry appears to be stabilizing in terms of the U.S. budget,” says Philip Finnegan, director of corporate analysis for Teal Group, based in Fairfax, Virginia. “The budget has been under pressure for several years, but there seems to be some emerging stability.”
It’s not just the U.S. that will boost defense spending, Finnegan said. Eastern European countries will likely open their wallets for defense as Russia becomes more aggressive, he says. Combine that with increased threats from Middle East countries, and global defense spending is expected to increase.
Europe will have to increase budgets and rely less on help from the U.S. in the next few years, says Brian Langenberg, principal at Langenberg & Co. in Chicago.
While spending in the U.S. is up, it isn’t increasing at a rapid enough pace to provide for certain contingencies in Europe, which means several former Soviet countries will need to make purchases of services and products for defense. “Europe is starting to develop its own defense strategy because it has to,” he says. “You could see a significant rise in spending in Europe.”
Several companies are already seeing shares improve as fears of terrorism or aggression spread.
General Dynamics Corp. (GD) shares have been on a roller coaster this year but the stock has outperformed both the Dow Jones industrial average and the Standard & Poor’s 500 index. The company recently had its stock upgraded to a buy rating from a hold by analysts at Argus, who set its price target at $160.
Lockheed Martin Corp. (LMT) shares have jumped 13 percent this year. The company has made several moves to improve its bottom line and recently landed a five-year, $969 million to build 17 C-130J military transport aircraft by 2020. The U.S. recently granted a request from France to acquire four Lockheed-built transport and fueling aircraft from the U.S. as part of a $650 million sales agreement.
Brian Ruttenbur, managing director for equity research at BB&T Capital Markets, says he’s also positive on the 2016 outlook for defense companies. The increased budget in 2016 “clears the way for general growth in the sector.”
Companies that provide services to the government rather than those that provide products likely will see the biggest gains next year because it takes less time to appropriate funds for services, such as technology platforms and consulting, than it does for physical items such as airplanes and tanks.
“The government services sector is the tip of the spear, so to speak,” Ruttenbur says. “After 9/11, that’s where we saw the biggest surge in spending. It takes a while for [companies that provide products] to turn it on, but government services are quick” to realize benefits.
Engility Holdings (EGL) is a stock to watch, he says, because it has a net-operating loss that allows increased tax deductions greater than its taxable income. Because of that loss, the company has about a $1.4 billion tax advantage. “Everybody in the industry is equally positioned, but because of that NOL, Engility has a tax advantage that’s not recognized by the Street,” he says.
Booz Allen has easy access to what Ruttenbur calls the “three-letter agencies,” including the FBI, the CIA and the Department of Defense, giving the company an especially bright outlook for 2016. BAH stock has gained about 12 percent this year.
CACI International (CACI) recently launched a device that can track down and identify drones, representing a shift for the firm from being solely a provider of technology services, Ruttenbur says.
The recent global terrorist attacks and fears of aggression by certain countries have brought defense spending into the fore and has left people wondering if the U.S. and its allies are well-prepared to defend themselves, Finnegan says, which should translate into increased spending globally.
“You have a threat environment that really encourages arms sales,” he says. “Obviously you have problems in the Middle East, the rise of a more-aggressive China, concerns in Eastern Europe about Russia and the increased threat of terrorism. This all comes together to encourage countries to stabilize their defense budgets, if not increase them.”
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Best Defense Contractor Stocks to Buy for 2016 originally appeared on usnews.com
