Geopolitical tensions move the markets.
The first major market catalyst of 2020 has been news of escalating geopolitical tensions between the U.S. and Iran. The U.S. military killed a top Iranian general in a Baghdad airstrike ordered by U.S. President Donald Trump on Jan. 3. Days later, Iran retaliated by launching a missile attack on military bases housing U.S. troops in Iraq. Although Trump has said Iran is now "standing down," investors are well aware of how quickly these situations can escalate. Here are seven defense stocks that could get a boost if military activity in the Middle East ramps up.
Boeing Co. (ticker: BA)
Boeing has had a difficult few quarters following the grounding of its 737 Max. While investors wait for the 737 Max to get the all-clear, Morningstar analyst Burkett Huey says the company's new leadership team needs to focus on providing a clear timeline and specific updates on the situation. Roughly a third of Boeing's income comes from defense products, and Huey says U.S. defense spending as a percentage of gross domestic product should remain steady barring any unforeseen conflict. Morningstar has a "hold" rating and $349 fair value estimate for BA stock.
Northrop Grumman Corp. (NOC)
Northrop Grumman provides aerospace and defense products, services and systems. Morningstar analyst Keith Schoonmaker says Northrop management has done an exceptional job expanding operating margins from 10% in 2010 to 12.6% in 2018. Schoonmaker says Northrop's aerospace systems revenue growth will outpace the overall increase in U.S. defense spending thanks in large part to its role in developing and producing the F-35 fighter jet. Schoonmaker says Northrop is being selective by only bidding on contracts that are the most lucrative for shareholders. Morningstar has a "hold" rating and $340 fair value estimate for NOC stock.
United Technologies Corp. (UTX)
United Technologies has plenty of potential catalysts ahead in 2020 after shareholders approved a $135 billion merger with Raytheon Co. (RTN) in October. The first step in that process will be for United to sell its Otis elevator business and its Carrier heating and air conditioning business. United's remaining Pratt & Whitney and Collins Aerospace divisions will merge with Raytheon to create defense giant Raytheon Technologies. Morningstar analyst Joshua Aguilar says the spin-offs of Otis and Carrier should unlock significant value for shareholders in the near-term. Morningstar has a "hold" rating and $153 fair value estimate for UTX stock.
Raytheon Co. (RTN)
It takes two to tango, and the other part of the Raytheon Technologies megadeal is Raytheon itself. United Technologies investors will receive a 57% stake in the combined company, while Raytheon shareholders will receive a 43% stake. Schoonmaker says Raytheon's backlog of contracts are now about 40% international compared to 28% international in 2012. That percentage of international contracts could rise further if tensions in the Middle East escalate, which is good news for investors given international contracts tend to have higher margins than domestic ones. Morningstar has a "hold" rating and $217 price target for RTN stock.
Lockheed Martin Corp. (LMT)
Lockheed Martin is the lead on the F-35 program, and Huey says exposure to the F-35 as well as missile and missile defense technology should help Lockheed outperform its peer group growth rate. Roughly 30% of Lockheed's contracts are international, and Huey projects missiles and fire control will be the company's fastest-growing unit over the next two years. Huey says Lockheed has a world-class management team that has prioritized capital returns, including a $3.3 billion buyback program (as of mid-2019) and a 2.3% dividend. Morningstar has a "hold" rating and $385 fair value estimate for LMT stock.
General Dynamics Corp. (GD)
Aerospace and defense contractor General Dynamics operates five business segments: aerospace, combat systems, marine systems, information technology and mission systems. The company delivered its first Gulfstream G600 aircraft in August and it recently said it expects to begin deliveries of the G700 jet in 2022. Schoonmaker says large vehicle orders from the U.S. Army, the UK and Saudi Arabia should boost sales over the next several years. Schoonmaker says the U.S. Army is due for a large-scale vehicle modernization program as well. Morningstar has a "hold" rating and $188 fair value estimate for GD stock.
War in the 21st century may be more digital than physical. Cybersecurity stock FireEye is not the typical defense stock, but it jumped more than 9% in the opening days of 2020 due to the Iran headlines. Last year, FireEye confirmed an Iranian phishing campaign aimed at the U.S. government. Analyst Mark Cash says FireEye's services, platform and cloud revenue growth have offset weakness in product sales. Cash says hackers will create increasingly complex attacks, creating a secular demand for new cybersecurity solutions. Morningstar has a "hold" rating and $15 fair value estimate for FEYE stock.
Defense stocks to buy as tensions rise:
-- Boeing Co. (BA)
-- Northrop Grumman Corp. (NOC)
-- United Technologies Corp. (UTX)
-- Raytheon Co. (RTN)
-- Lockheed Martin Corp. (LMT)
-- General Dynamics Corp. (GD)
-- FireEye (FEYE)
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