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Goldman Sachs: Our 3 Best Defensive Stocks To Buy Now

Defense is defensive. And that makes defense stocks a perfect choice for the current climate. So says Goldman Sachs. Its chief US equity strategist David Kostin has just revealed that the firm is recommending aerospace and defense stocks right now. Indeed, the iShares U.S. Aerospace & Defense ETF (ITA) is currently trading up 28% year-to-date. That’s versus the S&P 500’s 19% year-to-date gain, and 15% year-to-date return from the Dow Jones.

“During the past 10 years, Aerospace & Defense has been least sensitive to US and global economic growth across Industrials subsectors,” Kostin stated. He notes that these stocks tend to outperform the S&P 500 when the economy narrowly avoids a recession. What’s more, these stocks have the added benefit of “the lowest exposure to China”- a key selling point given the ongoing US-China trade tensions. With that in mind, let’s now dive in to three top aerospace and defense stocks singled out by Goldman Sachs for “the lowest reported sales to Asia Pacific”:

1. TransDigm Group Inc (TDG)

First up TransDigm- one of the best aerospace stocks out there. The company is a leading supplier of highly engineered aircraft equipment found on nearly all commercial and military aircraft today. Boosted by a strong fiscal third quarter, shares are already rallying an impressive 60% year-to-date. TransDigm reported FQ3 earnings of $4.95 per share, sailing past the Street's $4.30 consensus, thanks to 11.8% organic sales growth.  

In addition, the company also announced a special one-off dividend of $30 per share. “TDG will still have sizable ($2-3B+) dry powder for M&A/special dividends after the $30/sh special dividend is paid circa 8/23” cheered Cowen Co’s Gautam Khanna on the news. “Management indicates an active M&A pipeline, but of smaller assets. Thus, we would not be surprised if TDG announces additional special dividends in F20” the analyst continued. Indeed, TDG has a pattern of cashing out on similar generous dividends, including a one-time $22 per share dividend in 2017.

Meanwhile Credit Suisse analyst Robert Spingarn noted encouraging progress with TDG’s integration of its $4 billion purchase of Esterline Technologies. “ESL begins to emerge from the chrysalis” the analyst wrote, adding “after the first full quarter of ownership, ESL [is] already tracking higher than anticipated, with revenues +9%.” As a result, Spingarn hiked his price target from $539 to $617.

Similarly Goldman Sachs analyst Noah Poponak boosted his price target from $547 all the way to $623 on August 7. This Street-high price target indicates further upside potential of 21%. The analyst only recently reinstated coverage of TDG, citing significant recurring revenue, consistent and high margins, as well as strong cash generation and deployment.

As we can see here 9 out of 11 analysts covering TDG in the last three months rate the stock a buy- hence the Strong Buy Street consensus. Meanwhile, the $588 average analyst price target translates into 15% upside potential.

2. Huntington Ingalls Industries Inc (HII)

Welcome to HII- America's largest military shipbuilding company and a provider of services both the government and industry. Shares dropped 8.45% in August following disappointing Q2 results- but the Street is staying firmly onside. For instance, Alembic Global’s Peter Skibitski upgraded Huntington Ingalls to Buy from Hold on August 5, describing the weakness as a buying opportunity.

Meanwhile, five-star Cowen & Co analyst Gautam Khanna reiterated his HII buy rating following earnings, with a $250 price target (16% upside potential). Execution concerns are fair but overblown says Khanna writing: “While execution has been choppy, it appears isolated to a few, idiosyncratic issues vs. a wholesale unwind.” In particular, a 1x item ($12MM forward loss at Technical Solutions) made up 40% of the 14% EPS miss.

Looking forward the analyst believes there is cause for optimism, writing, “HII appears close to a shipbuilding margin uptick, and investor sentiment is awful, factors that keep us interested in this transitioning story.” For instance, management affirmed its 9-10% shipbuilding margin target in 2020, and indicated that this level is sustainable in 2021+.

3. Northrop Grumman Corp (NOC)

With annual revenue in excess of $30 billion, NOC is one of the world's largest weapons manufacturers and military technology providers. And Goldman Sachs isn’t the only firm singling Northrop out right now.

Shares popped 2% after Morgan Stanley analyst Rajeev Lalwani upgraded NOC from Hold to Buy, terming it the “best long-cycle play.” That’s with a bullish $418 price target (up from just $335 previously), indicating upside potential of 18% from current levels. In fact, year-to-date shares have already surged 45%. “We remain constructive on defense stocks and believe they are a good place to be,” the analyst told investors.

Turning to Northrop specifically, he explained: "growing sales visibility through the mid-2020s from a two-year budget deal pairs well with [valuation] amid uncertainty." According to Lalwani, NOC is "the best way to play the long-term strategic priorities of the U.S. government." He sees accelerating NOC profit margins and sales growth driving better than expected earnings.

"We believe NOC is well positioned given its longer duration capability and high-end technology focus, inflecting revenue and margins, portfolio shaping potential (via Technology Services), and an easing investment cycle that supports one of the highest FCF yields come 2021 at ~8%” the analyst wrote.

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