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Over the last five trading sessions, defense stocks have closed in the green thanks to geopolitical tensions that acted as a driver in the military and defense space otherwise beleaguered by budget constraints.

The U.S. Department of Defense (DoD) eased restrictions on Lockheed Martin Corp.’s (LMT - Analyst Report) fifth-generation fighter plane, the F-35. In another encouraging headline, the British government said that it will pay about 235 million pounds ($392 million) to the defense major Raytheon Co. (RTN - Analyst Report) for unlawfully terminating a contract for an electronic border control system.

(Read the last recap here: Defense Stock Roundup for Aug 12, 2014).

Iraq Update

Following a series of U.S. air strikes, Iraq’s Mosul dam – the largest dam of the country – was recaptured. Kurdish forces had been fighting with U.S. air support to retake it since Aug 16. The U.S. military used fighters, bombers, attack and unmanned aircraft to conduct 35 strikes and destroyed 90 targets including nine Islamic State (IS) positions and eight vehicles around the Mosul dam.

The recapture marks a major victory against the IS jihadists since they launched a major offensive in northern Iraq in June, brushing aside Iraqi security forces.

Meanwhile, Iraq’s Prime Minister Nouri al-Maliki resigned putting an end to his eight years of rule. This opens a new political period that U.S. officials hope will pose a more united front against IS militants. Mr. Maliki's departure came after intense pressure from other Shiite members of his political group, as well as Shiite religious figures. The U.S. and Iraq's close ally Iran have also been all for ousting Maliki.

Recap of the Week’s Most Important Stories
 
1.    Aerospace and defense operator Raytheon Company received a favorable decision from the Arbitration Tribunal, which settled the ongoing dispute between Raytheon Systems Limited (Raytheon UK) and the United Kingdom Home Office relating to the eBorders program (Read more: Raytheon Awarded Damages in UK Contract Termination Suit)

2.    The U.S. DoD has eased restrictions on Pentagon’s prime contractor Lockheed Martin Corp.’s F-35 jet. This allowed more than 20 test planes in the U.S. fleet to fly six hours between engine inspections instead of three.

Lockheed Martin’s F-35 Joint Strike Fighter – the world’s most expensive weapons system, costing around $400 billion – came across an unexpected hurdle following an emergency at Eglin Air Force Base in Florida on Jun 23, when a fire in the rear of one plane compelled the pilot to terminate a takeoff. The jets were grounded for three weeks after the incident, and have since been imposed with flight limitations. Contract talks between prime contractor Lockheed and engine manufacturer Pratt & Whitney – a unit of diversified conglomerate United Technologies Corp. (UTX - Analyst Report) – are now progressing for the upcoming batch of aircraft and engines.

3.    In a separate development, Lockheed Martin Aeronautics Company, a major unit of Lockheed Martin, received a $232.8 million contract from the U.S. Naval Air Systems Command (NAVAIR) to perform non-recurring sustainment activities, to include procurement of 19 training devices and 69 items of complex support equipment. The work on this contract is expected to be completed in Jun 2017. This is a modification to a $535.3 million F-35 Lightning II Low Rate Initial Production (LRIP) Lot VI contract awarded in Aug 2011.

4.    The Boeing Co. (BA - Analyst Report) won a $295.6 million contract from the U.S. Navy to buy parts required for production of 12 more P-8A spy planes, including 8 for the U.S. Navy and 4 for the government of Australia. The aircraft will substitute the P-3 spy planes of the U.S. Navy, which have been in service for more than 40 years. In February, Boeing had won a $2.1 billion contract to manufacture the initial batch of 16 P-8A Poseidon long-range maritime spy planes for the Navy.

5.    Northrop Grumman Corp. (NOC - Analyst Report) secured a $240.7 million U.S. Air Force contract for three Global Hawk unmanned aircraft of the Block 30 variety. Each unit will contain enhanced integrated sensor suite and an airborne signals intelligence payload (ASIP), as well as two additional ASIP sensors as retrofit kits. The work on this contract is slated for completion by the end of Jun 2017. This is a modification contract to a $114.2 million firm-fixed-price contract awarded in Sep 2013.

Performance

All the big defense stocks have closed in the green following quite a few weeks of volatility. The biggest gainer was L-3 Communications Holdings Inc. (LLL - Analyst Report), with Boeing close at its heels.

However, in the past six months, the market reaction has been more or less mixed. Although a few defense companies like Lockheed Martin, General Dynamics Corp. (GD - Analyst Report), Northrop Grumman Corp. and Textron Inc. (TXT - Analyst Report) have reported in the green, other behemoths like Boeing, Raytheon, Rockwell Collins (COL - Analyst Report) and L-3 Communications were in negative territory. General Dynamics is the sole defense stock to have gained in the double digits over the six-month time frame.

The following table shows the price movement of the major defense players over the past five trading days and during the last six months.
 

Company

Last Week

Last 6 months

LMT

+3.14%

+5.45%

BA

+3.73%

-2.66%

GD

+2.90%

+15.12%

RTN

+3.21%

-0.38%

NOC

+2.64%

+6.45%

COL

+2.38%

-4.43%

TXT

+0.85%

+1.88%

LLL

+4.07%

-4.69%

 
What’s Next in the Defense World?
 
The defense sector is up against an apathetic market as military budgets remain under pressure in the U.S. and the easy upward slope of last year is likely to hit a plateau. Yet, the ongoing Iraqi civil war, escalating tensions in Eastern Europe and demand for defense products in the Middle East and other Asian nations keep the hope alive for the sector.

We remind investors that the Zacks Industry Rank for aerospace/defense is within the top one-third of the list of 260-plus industries. Hence, the prospects for this industry are still very much in place. We however expect the slightly flat-to-bearish run of the defense stocks to persist in the coming days (to know more please see: Zacks Industry Rank).
 
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