With an annual budget north of $4.4 trillion, The U.S. is the largest single consumer of virtually everything it purchases. The defense portion of U.S. expenditures naturally rises in time or war, but with conflict in Iraq and Afghanistan greatly reduced, had settled into a range between $560 and $600 billion annually during the second term of the Obama administration.
As of 2016, the United States accounted for more than a third of global defense spending and it’s been on the rise since then.
President Trump campaigned on a promise to “rebuild our depleted military” and in office, he’s living up to that promise.
Trump signed into law the 2019 National Defense Authorization Act, committing $716 billion to defense spending during the fiscal year. Even when other budget consideration remain unresolved, Congress and the President have an easy time agreeing on defense spending.
Texas Republican Rep. Mac Thornberry, chairman of the House Armed Services Committee suggested that even higher defense budgets are on the horizon, saying of the 2019 allocation, “The first job of the federal government is to defend the country. We’re doing that on about 15% of the federal budget, but we’ve cut too much in the past eight years and we have to make up for some of the ground that’s been lost.”
Northrop Grumman Corporation (NOC - Free Report) supplies a wide range of Military systems to the U.S and also other countries. The business is broken down into four main categories – Aerospace Systems, Mission Systems, Technology Services and the newly acquired Innovation Systems.
In the Aerospace division, Northrop produces aircraft, spacecraft, high-energy systems and microelectronics. Mission Systems makes military radar, sensors and related products. Technology Services works on the entire lifecycle of civil and defense platforms through a wide range of services, including logistics, security, network operations and integrated air and missile defense serving not only the U.S government and other Sovereign nations, but also municipalities like the state of Virginia. Finally, Innovation Systems was borne from the acquisition of Orbital ATK and is a leader in space, defense and flight systems.
Defense stocks are also generally defensive stocks, providing stable earnings regardless of the state of the overall stock market. With a beta of 0.76, NOC shares tend to move considerably less than the broad markets, especially during times of turmoil. In fact, periods of armed conflict – which cause significant uncertainty for most stocks – are actually the best times for defense companies as nations expand their offensive capabilities and refresh depleted resources.
Another positive aspect of the defense sector is that these companies generally have an easier time passing along cost increases to their customers than other industrial companies. When rising steel, oil or labor costs increase the price of finished goods, ordinary consumers can much more easily choose to delay the purchase of an automobile or even a tractor, but the government can’t necessarily put off defense purchases. Defense companies are also naturally resistant to trade wars and tariffs, because governments are unlikely to enact tariffs on goods and services of which they themselves are the purchasers.
In their most recent earnings report, NOC handily beat the Zacks Consensus Estimates of $4.74/share in earnings, with $5.49/share in earnings on sales of $8.48B.
Analysts expect $20.38/share in earnings in full year 2019 and $23.01 in 2020. Both have been revised upward several times over the past quarter.
Northrup Grumman is a Zacks Ranks #2 (Buy).
Northrop also pays a 1.5% dividend, and has over $2.5B in Free Cash Flow to back it up.
There’s one more story that bodes well for the futures at Northrop Grumman. The most recent defense budget bill also provided the framework for the development of an additional branch of the US military – the Space Force.
The establishment of the Space Force will likely be a windfall for Northrup Grumman. It’s a fair bet that a company with Northrop’s expertise in the space sector would make it a natural choice for the goods and services the new division would require. Until we know more about the ultimate size and shape of the Space Corps, this is a non-quantifiable wildcard, but one with the potential to create a strong tailwind for the company.
In an investing environment that includes all sorts of apparently hidden risks – trade wars, rising commodity prices, increased labor costs, etc., there are some companies that appear particularly well-equipped to weather the storm. With the support of a Presidential administration devoted to increased defense spending, Northrop Grumman belongs in any well-diversified portfolio.
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