U.S. Markets closed

3 Top Defense Stocks to Watch Right Now

John Bromels, Rich Smith, and Tyler Crowe, The Motley Fool

Playing defense is never fun -- unless you're buying defense stocks, and then it can be a lot of fun (for your portfolio, that is).

But finding the right defense stock is never easy. That's why we asked three Motley Fool contributors what defense stocks they'd keep an eye on now. They came back with AeroVironment (NASDAQ: AVAV)Kratos Defense & Security Solutions (NASDAQ: KTOS), and Oshkosh Corporation (NYSE: OSK). Here's why they think these stocks are worth keeping on your radar screen (no pun intended).

Drones fly over a building

Top stocks in the defense industry can help your portfolio soar. Image source: Getty Images.

Can this high-flying drone stock get back on track?

Tyler Crowe (AeroVironment): When it comes to what defense investors want out of a company these days, AeroVironment would appear to check all the boxes. Its unmanned aerial drones are at the forefront of battlefield technology, and they can perform some conventional aircraft tasks for a fraction of the price. The company has a high percentage of international sales (47% in fiscal 2018) that could lead to higher overall sales and less dependence on the congressional purse strings. On top of enjoying those benefits as a defense contractor, the company is also exploring many commercial applications in agriculture, broadband communication, and infrastructure. 

AeroVironment's stock was a reflection of all that promise over the past few years, with its shares soaring more than 250% over the past five years. That momentum hit a speed bump during its fiscal second-quarter earnings report back in November. Net income fell about 20% compared to the prior year even though it benefited from a lower corporate tax rate. The drop in the bottom line was largely attributed to sluggish product sales, higher expenses, and elevated research and development spending. Since their peak in September, shares are down more than 29%.

The upside is that drone use is expected to go nowhere but up from here. Goldman Sachs estimates the drone market will reach $100 billion by 2020, $70 billion of which will be in defense. Also, the company is plowing more and more money into autonomous aerial vehicles that could open up a whole new realm of possibilities in the drone segment. 

Investors should be on the lookout for AeroVironment's next quarterly report to see if the company was able to correct course. If the company can offset expenses with higher sales prices and can start to make inroads with its autonomous offerings, this recent share drop could look like an opportune time to buy. 

Can Kratos turn things around in 2019?

Rich Smith (Kratos Defense & Security): January was a big month for big defense stocks, with big names like Boeing, Lockheed Martin, and Raytheon reporting their Q4 and full-year results. By the time February rolled around, the defense earnings news was just about all out -- except for Kratos Defense & Security.

This pioneer in the market for jet-powered military drones reported Q3 earnings three months ago, on Nov. 6, and its Q4 numbers should come out any moment now.

What will investors be looking for? Well, in November, Kratos predicted it would end this year with revenue of $635 million to $645 million, probably no GAAP earnings (but positive "adjusted EPS" of $0.18 to $0.21), and positive free cash flow of $5 million to $12 million.

It's going to be really interesting to see how investors react to this news. Even $645 million in revenue will be less revenue than Kratos has booked since as far back as 2010 -- and a 14% decline from last year. On the other hand, even an $0.18 "adjusted" profit will be 50% better than what Kratos earned last year. And free cash flow? Kratos hasn't generated a real, full-year cash profit since 2013 -- so generating positive FCF in 2018 would be really big news.

Can Kratos Defense & Security do it? Keep eyes out for the news -- Kratos is scheduled to report later today.

A hybrid defense contractor

John Bromels (Oshkosh Corporation): If you're concerned about how defense stocks might fare under divided government, you're not alone. When a company has the U.S. military as its primary customer, any sign of discord in Washington has to raise red flags. 

For investors who would like to include a defense stock in their portfolio, but maybe aren't ready to go "all in" by buying shares of a pure play on defense, Oshkosh Corporation makes an attractive hybrid play. The specialty-truck maker does have a robust defense division, supplying Joint Light Tactical Vehicles (JLTVs) and Mine-resistant All-Terrain Vehicles (M-ATVs) to the U.S. Department of Defense and other international clients. 

Oshkosh also sells fire trucks, cement mixers, aerial work platforms, and a number of other specialty trucks. Business is booming as sales have risen steadily for the last three years, with net income rising just as steadily over the last two. But in spite of all that, the company's stock had a rotten 2018. This was due to a combination of factors, including fears that a global economic slowdown would curb demand for large purchases like trucks, concerns that steel and aluminum tariffs would impact the company's revenue, and disappointment that promised federal infrastructure spending -- which would likely have benefited sales of Oshkosh's construction vehicles -- failed to materialize. 

But Oshkosh is on a tear in 2019, with the stock up more than 25%. That's thanks to the company posting stellar Q4 2018 results and calming investor fears by raising its 2019 guidance. In spite of that uptick in share price, though, Oshkosh is still down about 10% from its early 2018 high, and is trading at a modest 12.4 times earnings -- near a record low. You'll want to keep an eye on this "slow and steady" outperformer.

More From The Motley Fool

John Bromels owns shares of Oshkosh. Rich Smith has no position in any of the stocks mentioned. Tyler Crowe has no position in any of the stocks mentioned. The Motley Fool recommends AeroVironment. The Motley Fool has a disclosure policy.