A marketplace in Kabul after the Taliban seized control of the capital following the collapse of the Afghan government.
Hoshang Hashimi / AFP via Getty Images
The U.S. withdrawal from Afghanistan will have wide-ranging implications for the defense sector. The stocks should benefit as the stability of the region declines.
“Kabul has fallen,” writes Truist aerospace and defense analyst Michael Ciarmoli in a Monday research report. “Future stability in the region now appears to be anything but.” That lack of stability, combined with Taliban control of the country, “will certainly influence U.S. defense strategy, potentially spending, and could have positive implications for the sector,” he adds.
Demand for intelligence, surveillance, and reconnaissance missions could increase, along with demand for unmanned systems, missiles, and satellite capabilities.
The defense sector is relatively concentrated. The large integrated players include Lockheed Martin (ticker: LMT), Raytheon Technologies (RTX), Northrop Grumman (NOC), L3Harris Technologies (LHX), and General Dynamics (GD). Smaller players, including Mercury Systems (MRCY) and Kratos Defense & Security Solutions (KTOS), could also benefit.
Mercury supplies a lot of electric components to other defense companies. Almost half of its revenue is generated from sales to Lockheed, L3Harris, Northrop, and Raytheon.
Kratos has unmanned, hypersonic technologies. More than 70% of its sales come directly from the Defense Department.
The performance of the defense sector has been mixed so far in 2021. Lockheed stock is up less than 2% through Monday, trailing behind the 19% and 16% respective gains of the S&P 500 and Dow Jones Industrial Average.
Shares of General Dynamics, Raytheon, L3Harris, and Northrop, on the other hand, are up about 25% on average.
Shares of Kratos and Mercury, however, have dropped 20% and 41%, respectively, so far in 2021.
The largest defense stocks still trade at a discount to the market. Lockheed trades for 13 times estimated 2022 earnings. Mercury trades for about 18 times estimated 2022 earnings. Kratos looks like the most expensive trading for about 42 times that number. The other three trade for about 16 times earnings. The S&P 500 trades for about 20 times estimated 2022 earnings.
Analysts like defense stocks. The lowest Buy-rating ratio for any of those six stocks is 60%. The average Buy-rating ratio for stocks in the S&P 500 is about 55%. Raytheon and Northrop are Wall Street favorites, with more than 80% and 70%, respectively, of analysts covering the company rating shares Buy.
Ciarmoli, for his part, recommends L3Harris shares, on which he has a price target of $258. He doesn’t cover Lockheed, Raytheon, General Dynamics, or Northrop. He rates Mercury and Kratos Hold.
Write to Al Root at [email protected]
