XAR: Looking to Play Defense? Check Out This Defense ETF
The SPDR S&P Aerospace & Defense ETF (NYSEARCA:XAR) is a strong aerospace and defense ETF with some intriguing top holdings in its portfolio. I’m bullish on the $2.1 billion ETF from State Street (NYSE:STT) based on a macro situation where conflict is escalating globally, leading more countries to invest in defense and its intriguing group of top holdings, like AeroVironment (NASDAQ:AVAV), which are thus reporting surging demand and a growing backlog.
What Is the XAR ETF’s Strategy?
According to State Street, XAR “seeks to provide investment results that… correspond generally to the total return performance of the S&P Aerospace & Defense Select Industry Index,” which gives investors exposure to the Aerospace and Defense segment of the S&P Total Market Index (TMI).
The Allure of Defense Stocks
Data from the Uppsala Conflict Data Program shows that, unfortunately, the number of wars around the world has sharply increased in recent years, from under 100 in 2010 to nearly 200 today. This is a sad situation, but the reality is that with heightened tensions worldwide, many countries feel the need to ramp up defense spending, which is a boon to the stocks that XAR holds.
These defense companies can often be good investments because they enjoy long-term contracts with stable customers (like the U.S. Government) and spending that is uncorrelated with the consumer economy.
Additionally, these companies enjoy significant barriers to entry, as it is a difficult field to break into, and they have strong, established relationships with their customers (national governments). Furthermore, it may sound obvious, but these stocks are also defensive in nature, as they can perform well in market backdrops of geopolitical tension that can cause other stocks to sink.
Intriguing Top Holdings
XAR owns just 35 stocks, but its top 10 holdings make up just 45.1% of the fund, so it isn’t overly dominated by a few large holdings.
Below is an overview of XAR’s top 10 holdings using TipRanks’ holdings tool.
As you can see, one of the fund’s largest holdings is AeroVironment, a defense company that manufactures drones and other unmanned vehicles. AeroVironment recently reported blowout quarterly results, generating record third-quarter revenue of $187 million, a nearly 40% increase year-over-year.
AeroVironment’s Loitering Munitions segment reported record quarterly revenue as sales more than doubled year-over-year, thanks to what CEO Wahid Nawabi called “high demand across the globe.” The company is continuing to increase production to try to keep up with “surging demand.”
Over 20 countries are interested in acquiring its Switchblade drone, with more than a third seeking export authorization from the Department of Defense. While this was the segment’s best quarter ever, Nawabi said, “We believe we’re only getting started.”
Not only that, but AeroVironment also grew its bottom line, blowing away analyst estimates that it would earn $0.33 per share by reporting adjusted EPS of $0.63. The company swung from a loss during the year-ago period to net income of $13.9 million.
AeroVironment CEO Wahid Nawabi said that the company “is on track to have its best year ever,” thanks to “record demand and strong operating execution.” The strong quarter and record demand prompted management to raise and tighten guidance for the rest of the year, and the company expects revenue to continue growing at a double-digit rate in Fiscal 2025. AeroVironment’s backlog is up 12% versus last year.
AeroVironment’s spectacular results are important because not only is AeroVironment one of XAR’s top holdings, but its results may provide a read-through for the rest of the space. If AeroVironment is significantly increasing revenue thanks to “record demand,” then this is likely a favorable environment for other defense companies as well.
AeroVironment receives an impressive Smart Score of 8 out of 10. The Smart Score is a proprietary quantitative stock scoring system created by TipRanks. It gives stocks a score from 1 to 10 based on eight market key factors. A score of 8 or above is equivalent to an Outperform rating.
While the Smart Score doesn’t give all of the stocks within XAR’s top holdings Outperform ratings, it rates some holdings highly, such as Howmet Aerospace (NYSE:HWM) with a 9 out of 10 Smart Score, and Textron (NYSE:TXT) and Raytheon Technologies (NYSE:RTX), which both enjoy ‘Perfect 10’ Smart Scores.
Like AeroVironment, Textron is also seeing strong demand and increased its full-year guidance to a range of $6.20-6.40 per share versus average Wall Street estimates of $5.96 per share. Textron has a growing backlog, which grew by over 10% to $7.2 billion.
Meanwhile, not only does Howmet Aerospace sport a high Smart Score, but this maker of engineered solutions for aerospace and transportation industries, like engines and forged wheels, reported full-year revenue growth of 17% and full-year adjusted EPS growth of 31% in February. The company has posted 10 consecutive quarters in which revenue, adjusted EBITDA, and adjusted EPS have grown.
Lastly, another attractive aspect of XAR is that it isn’t overly exposed to troubled Boeing (NYSE:BA) stock, which has a weighting of just 2.9% in the fund. This is a much smaller exposure than a competitor like the iShares U.S. Aerospace & Defense ETF (BATS:ITA), where Boeing has a 14.7% weighting.
XAR’s Long-Term Performance
As of February 29, XAR has generated a somewhat underwhelming 5.3% annualized return over the past three years. However, its results are better over the longer term, with an 8.2% annualized return over the past five years and an 11.4% return over the past decade. Zooming further out, the fund has returned a much more compelling 16.1% on an annualized basis since its inception in 2011.
While XAR’s return over the past three years is somewhat lackluster, its performance over a longer time horizon inspires confidence. And if we are in an environment of escalating conflict, not to mention soaring demand, like the AeroVironment CEO discussed on the company’s earnings call, then XAR’s performance could start to tick upwards.
What Is XAR’s Expense Ratio?
XAR features an expense ratio of 0.35%, meaning that an investor in the fund will pay $35 in fees on a $10,000 investment annually.
This is a fairly middle-of-the-road expense ratio, but it’s also important to note that it makes XAR cheaper than its two closest peers within the aerospace and defense ETF landscape, the aforementioned ITA and the Invesco Aerospace & Defense ETF (NYSEARCA:PPA), which charge 0.40% and 0.58%, respectively.
Over the course of 10 years, assuming that each fund returns 5% per year annually, the investor who put $10,000 into XAR will pay $443 in total fees. Meanwhile, the investor in ITA would pay a slightly higher $505 in fees, and the investor in PPA would pay a significantly higher $726 in fees.
Below is a comparison of XAR, ITA, and PPA created using TipRanks’ ETF Comparison Tool, which allows investors to compare up to 20 ETFs at a time across a variety of customizable factors.
Is XAR Stock a Buy, According to Analysts?
Turning to Wall Street, XAR earns a Moderate Buy consensus rating based on 24 Buys, 11 Holds, and one Sell rating assigned in the past three months. The average XAR stock price target of $163.18 implies 17.7% upside potential.
Investor Takeaway
XAR is a solid defense and aerospace ETF with a best-in-class expense ratio. Its three-year annualized performance has been uninspiring, but over a longer time horizon, this has been a strong performer. With various conflicts heating up around the world and top holdings like AeroVironment reporting escalating demand and growing backlogs, XAR seems like it can trend upward and potentially be a sound long-term holding due to the defensive nature of its holdings.
