An Air Force plane leaves after landing Afghan evacuees in Spain on Tuesday.
Pablo Blazquez Dominguez/Getty Images
The U.S. withdrawal from Afghanistan may have added to concern about the outlook for defense companies, but it shouldn’t have. The stocks still offer good value for anyone who isn’t a growth investor.
“We doubt if the end in Afghanistan will have any more impact on the US psyche than the withdrawal from Iraq,” wrote Vertical Research Partners analyst Rob Stallard in a Wednesday report.
The Afghan war stretched over 20 years, so the exit is a quite a milestone for the U.S.. Yet the implications for the military budget aren’t significant. Afghanistan was due to consume about $9 billion in fiscal year 2022 spending, according to Stallard.
The total defense-funding request from President Joe Biden tops $750 billion. compared with the $741 billion spent in the current fiscal year. That is small growth, but it is still growth.
“We see the conclusion of the longest war in US history as dovetailing with the shift from counter terrorism to containing China, and an increased aversion in the West to open ended military expeditions,” added the analyst. There are still conflicts and concerns for the defense industry to tackle.
Stallard still sees good value in defense stocks, noting that the major U.S. defense contractors are trading at about 14 times estimated 2022 earnings. That is a discount to the multiple of 21 times for the S&P 500.
Among defense names, Stallard rates shares of General Dynamics (ticker: GD), L3Harris Technologies (LHX), Northrop Grumman (NOC), Textron (TXT), Raytheon Technologies (RTX), Lockheed Martin (LMT) and BAE Systems (BA/.London) at Buy. That septet trades at an average of about 15 times estimated 2022 earnings.
Year to date, those stocks are up an average of about 22%, better than the 21% and 16% respective returns of the S&P 500 and Dow Jones Industrial Average. But the spread in performance is wide. Lockheed shares are flat, while Textron stock has risen 48%.
Among Stallard’s peers, Raytheon and Northrop are the favorites. About 80% of analysts covering Raytheon rate shares Buy and 68% rate shares of Northrop at Buy. All seven stocks have Buy-rating ratios higher than the average of 55% for stocks in the S&P 500.
The problem for defense stocks, and for defense investors, isn’t analyst sentiment. It is the potential for long-term earnings growth given that the U.S. defense budget is likely to be flat, or increase only slowly. As worry over the short-term implications of the Afghanistan withdrawal fades, that is the issue investors will have to address.
Over the next two years, the outlook appears positive. The seven defense stocks are expected to increase their earnings per share by an average of about 12% a year. That is actually better than the 10% growth forecast for the S&P 500.
There is a large spread among the defense stocks, however. Raytheon and Textron are expected to increase their earnings by about 20% a year on average. Earnings for the other five are expected to increase, but more slowly than for the market as a whole.
Write to Al Root at [email protected]
