Aerospace & defence stocks: Policy Overview

 
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Both candidates are strong on the military but there are some important considerations for stock pickers once you dive down into the detail.

Hillary Clinton is the continuity vote – conventionally strong on defence and probably more hawkish than Obama. She voted for the invasion of Iraq in 2003 but says she regrets this.

She is seen as more willing to use force and maintain a strong American military presence in places like the Middle East. However she has said she will not send ground troops to Iraq or Syria to defeat ISIS. Spending is likely to be at least as much as under the Obama administration.

Donald Trump could spend a lot, lot more on the military.

He wants to reverse the cuts to defence spending enacted under the 2013 budget sequester. He believes the US military is understaffed, and under-equipped to deal with the threats it faces.

In effect he could spend tens of billions of dollars more on planes, troops and ships.

As a flavour, ditching the sequester would amount to $500bn more over ten years. With defence spending running at annual pace of $600bn, that would be a roughly 10% increase per annum.

“History shows that when America is not prepared is when the danger is by far the greatest. We want to deter, avoid, and prevent conflict,” he said in September.

But Trump could be negative for some defence stocks as he’s threatened to cut out what’s perceived as immense waste in the system. When the Pentagon is spending tens of billions on unused weapons systems, there is a sense that defence contractors are getting away with grand larceny. There is a longstanding belief that defence firms and politicians are working together to spend taxpayers’ money without much to show for it. One commonly cited example is Lockheed Martin’s F-35 programme, which is set to cost $1.5 trillion, around 50% above the initial estimate.

Profits could slide if stricter cost control is exercised by government, although the chances of a significant reduction is relatively low considering other fundamentals.

Speaking on Meet the Press about the US military, Mr Trump said: “It’s gonna be so strong, nobody’s gonna mess with us. But you know what? We can do it for a lot less.”

This chimes with Trump’s broader economic policy, which involves lower taxes and higher spending.

Fundamentals

Both candidates are pro military and likely to spend more than the previous administration. The fundamentals seem to support defence – global threats appear to be on the rise. Russia’s new-found confidence in foreign policy is also posing new and greater threats than at any time since the end of the Cold War. China continues to get stronger and is bullying America’s regional allies in Asia. All these factors point to steadily increasing spending on defence, which should support stocks in the sector, particularly those manufacturing highly specialised technology.

 

Stocks to watch

 

It’s hard to look past the big three defence firms - Raytheon (RTN), Northrop Grumman (NOC) and Lockheed Martin (LMT).

But The Boeing Company (BA), General Dynamics (GD) and L-3 Communications (LLL) are also strong players in the sector which all recently benefited from the US government’s $38bn military aid deal for Israel.

Defence stocks have all done very well even with the sequester hitting the military budget. Under Obama defence spending has been still be high and it’s no surprise that the S&P 500 Aerospace & Defence index has risen from around 3,500 in September 2011 to approximately 8,500 as of September 23rd 2016.

The big three have all delivered some very impressive increases since 2011.

Analyst views:

As of October 7th, Nasdaq data showed analysts were fairly bullish about defence stocks.

RTN was listed by 10 analyst firms as a ‘strong buy’ and two as ‘hold’. Of the analysts offering 12 month price targets for Raytheon quoted by the Financial Times, have a median target of 158.00, with a high estimate of 170.00 and a low estimate of 140.00. The median estimate represents a 15% rise.

NOC is similarly solid – 4 ‘strong buy’ and six ‘hold’. According to the Financial Times, the median 12-month price target is 231.00, which would be over 6% the price of Sept 23rd.

LMT seems comparatively out of love – perhaps because of the bad press around the F-35 programme – although with 4 strong buy, 5 hold and one sell, it’s still seen in a good light. FT data shows a median target of 260.00, which represents an increase of more than 10% from the stock’s level of October 7th.

BA – FT data shows strong consensus to outperform. The 12-month median target of 155.00 among 15 analysts would be a 17% increase from Sept 23rd.

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