The Withdrawal of the US from Afghanistan may have contributed to concerns about the outlook for defense companies, but it shouldn’t be. The stock still offers good value for anyone who is not a growth investor.
“We doubt that the end in Afghanistan will have more of an impact on the American psyche than the withdrawal from Iraq,” Vertical Research Partners analyst Rob Stallard wrote in a Wednesday report.
The Afghan war stretched over 20 years, so the exit is quite a milestone for the US. Still, the implications for the military budget are not significant. According to Stallard, Afghanistan would consume about $9 billion in fiscal year 2022.
President Joe Biden’s Total Defense Fund Request surpasses $750 billion. compared to the $741 billion spent in the current fiscal year. That’s a small growth, but it’s still growth.
“We see the end of the longest war in US history as a shift from counterterrorism to containment of China, and an increased distaste in the West for open-ended military expeditions,” the analyst added. There are still conflicts and concerns for the defense industry to address.
Stallard still sees good value in defense stocks, noting that the major US defense contractors are trading at about 14 times estimated 2022 earnings. That’s a discount to the multiple of 21 times for the
Under the names of the defense, Stallard estimates shares of
(BA/.London) at Buy. That septet is trading at an average of about 15 times its estimated 2022 earnings.
Year-to-date, those stocks have risen about 22% on average, outperforming the respective returns of 21% and 16%.
Dow Jones industrial average.
But the spread in performance is large. Lockheed shares are flat, while Textron shares are up 48%.
Among Stallard’s colleagues, Raytheon and Northrop are the favourites. About 80% of the analysts who rate Raytheon buy shares, and 68% rate Northrop shares at Buy. All seven stocks have a Buy rating ratio that is higher than the 55% average for stocks in the S&P 500.
The problem for defense stocks and for defense investors is not analyst sentiment. It is the potential for long-term earnings growth, as the US defense budget is likely to remain flat or increase only slowly. As concerns about the short-term implications of Afghanistan’s withdrawal wane, that’s the issue investors will need to address.
The outlook for the next two years looks positive. The seven defense stocks are expected to increase their earnings per share by an average of about 12% per year. That’s even better than the 10% growth forecast for the S&P 500.
However, there is a wide spread between defense stocks. Raytheon and Textron are expected to increase their revenues by an average of about 20% per year. Earnings for the other five are expected to rise, but more slowly than for the market as a whole.
Write to Al Root at email@example.com