Houston, we have a Virgin Galactic problem, strategist says

As geopolitical risks and investment in scientific advancements for space exploration continue, many investors are curious how to manage their portfolios to capitalize on potential aerospace winners.

Yahoo Finance has investors covered with this edition of Good Buy or Goodbye, as Kevin Mahn, Hennion & Walsh CIO, provides insight into which companies may have the best setup for future success in aerospace defense and more.

Walsh picks Northrop Grumman Corporation (NOC) as a "Good Buy" citing a potential benefit from increased defense spending from the US, a strong stock performance with a gain of 2% year-to-date, and has an Altman Z score of 4.2, keeping them far away from bankruptcy.

Walsh says to stay away from Virgin Galactic (SPCE) citing very little potential to gain from an increase in US defense spending, the stock is struggling, with the potential to get worse, has a weak balance sheet with negative earnings, and no dividend.

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Nicholas Jacobino

Video Transcript

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JOSH LIPTON: It is a big noisy universe of stocks out there. Welcome to "Good Buy or Goodbye," our goal to help cut through that noise to navigate the best moves for your portfolio. And today we're going to take a deeper dive into the aerospace and defense industry as more government funding is made available and, of course, geopolitical events persist. What is the best way to play it now? I'm here with Kevin Mahn, CEO of Hennion and Walsh Asset Management.

Kevin, it is great to see you.

KEVIN MAHN: It's great to be with you.

JOSH LIPTON: I want to start, Kevin, with maybe get a look at the Fed's outlook for US GDP. Now that's what they're seeing, Kevin, but I'm interested to get Kevin's look. How do you see the US economy, Kevin, kind of unfolding here in 2024? Are you in the soft landing camp, the downturn camp? Where are you?

KEVIN MAHN: Sure. The long awaited economic slowdown is finally coming to fruition. And I think the Fed's own projections here bear that out. If you look at 2024, the Fed has projected that GDP is going to slow to 1.4% and then stay below 2% all the way through the end of the year.

Now that's a slowdown, and that should be a relatively soft landing. What could take that soft landing into an economic recession is if they keep rates too high for too long. I don't think they will. I think they're going to start cutting interest rates towards the second half of this year and keep that slowdown from coming into a recession. So, yes, I'm in the soft landing camp for now. But an economic slowdown is coming, and investors would be wise to position their portfolios into areas such as health care, consumer staples, and industrials, notably the aerospace and defense sector.

JOSH LIPTON: Yeah. Let's dig into that. So that's the backdrop, now let's talk about where you see buys. One name, and I think our viewers are going to recognize this one this, is Northrop Grumman. You believe, Kevin, this one is a buy here. It's one people should commit capital to.

Let's go some of the reasons for this. First one, you have, Kevin, here since it's your bullets, why you think this one's wants to own may gain from defense spending. Talk about that with us.

KEVIN MAHN: Absolutely. Over the course of the next decade, defense spending in our country is projected to increase from roughly $783 billion to $1.2 trillion. That's nearly a 50% increase over the next decade. We also know that since 1960 as a percentage of our GDP, military spending has decreased every single year, gone up in dollar terms, gone down as a percentage of GDP. So we need to increase defense spending, which has only been further drained by us helping out necessarily so other countries across the globe over the last two years and likely in the year ahead.

So who's going to be the primary benefactor of this increase in defense spending? One such name is Northrop Grumman.

JOSH LIPTON: All right. Second bullet point there, strong stock performance.

KEVIN MAHN: Absolutely. Up just over 2% year-to-date over the last three years, annualizing out to about 19% per annum. That's pretty good, especially for a defensive defense name.

JOSH LIPTON: And finally here, final bullet point, strong balance sheet pays a dividend. So a strong balance sheet and you like the capital return.

KEVIN MAHN: Absolutely. So it's got a dividend yield of around 1.5%. And here's the statistic for all the viewers to look at, it's called the Altman Z-score. It was pioneered by an NYU professor, right around the corner from here, back in 1968. And it helps to predict the probability of a company declaring bankruptcy over the next two years. So those companies with an Altman Z-score are three or better are less likely to declare bankruptcy. Those with three or below are more likely.

Guess what? Their Altman Z-score, 4.2. Strong balance sheets, pays a dividend, likely to be a benefactor of increased defense spending, and their stock's been doing pretty well.

JOSH LIPTON: All right. Kevin, so you've made a very strong case here. Before our viewers decide, they're going to go all in, commit capital to Northrop Grumman. Talk about some of the risks they should consider.

KEVIN MAHN: Certainly. This is a presidential election year. We don't know who ultimately is going to be running for president, much less likely to occupy the Oval Office over the course of the next four years or who's going to be in control of Congress. What if that forecast increase in defense spending doesn't come to fruition? That's certainly a risk for this type of outlook.

JOSH LIPTON: And one last question before we move on, Northrop Grumman is a buy. What about some of the peers? Lockheed Martin, is that also another name you like?

KEVIN MAHN: Absolutely, Josh. Lockheed Martin is another name that we like, and we hold within one of our portfolios at smart trust, has a little bit more of an attractive dividend yield of roughly 2.6%. The exact same Altman Z-score of 4.2, but also trading in an attractive valuation and with a PE of around 16 right now.

JOSH LIPTON: All right. So we got the name you like. Let's move on. Which name you don't like, Kevin? Another one, I think, by the way, viewers are going to be very well aware of Virgin Galactic. Let's go through some of the reasons here. First one, unlikely to gain from defense spending.

KEVIN MAHN: I can't imagine any of these forecasted increases in defense or military spending going towards individual manned spacecrafts. This is obviously no disrespect to Sir Richard Branson. It's in the aerospace and defense sector. But it really isn't a defense name. It's an aerospace name. And it's a luxury item, not a staple item.

JOSH LIPTON: All right. Second reason here, now the stock a struggling, and struggling is putting it kindly here, right? I mean, this stock has been hammered, right? Kevin, it's down about 65% in the past 12 months. That's another reason you're saying to avoid it. You don't think-- you don't think all the bad news is priced in here?

KEVIN MAHN: I think there's even more downside from here. Down 20% year-to-date over the last three years, it's down around 59% per annum over that time period. I just don't see the outlook for this getting better, especially if we're going into that economic slowdown period that we spoke about earlier. What individuals are going to pay the money to actually fly to space? There's a very low likelihood of that. And we'll get to the other reasons why. I think this company is going to struggle. But certainly, the space is an area, pun intended, that's not going to get a lot of attention.

JOSH LIPTON: And this one, the third reason, basically, you're saying, this is the polar opposite of Northrop Grumman.

KEVIN MAHN: Absolutely. Negative earnings, their Altman Z-score is negative. So there is a high likelihood of this company declaring bankruptcy over the next two years, at least according to that statistic. They don't pay a dividend. And it's just tough to imagine them growing their balance sheet, growing their earnings in the likelihood of a slowing economy that's forecast over the next three years.

JOSH LIPTON: And let's end here, Kevin. So before you decide to avoid this name altogether, your point being we're not getting a lot of cooperation here on the tech side. It's OK, we've got Kevin here to walk us through it.

KEVIN MAHN: No problem.

JOSH LIPTON: What are some upside risks here? In other words, what would turn you bullish on this name?

KEVIN MAHN: Sure.

JOSH LIPTON: Here we go. Now we got it.

KEVIN MAHN: The company is still bullish that they can actually launch the Delta spacecraft. And they forecast that they could potentially be cash flow even by the end of 2026. Time will tell. Those forecasts seem to be coming from outer space to me. So this is a name that I put in the goodbye category, not the good buy category.

JOSH LIPTON: All right. So let's sum this up here for the viewers paying attention. So you're telling investors by Northrop Grumman due to its healthy balance sheet, strong performance, the potential to take a slice of that government defense spending. On the flip side, though, Kevin is saying avoid Virgin Galactic as it is not likely to receive any of that funding, the lack of dividend, and its poor performance over the last few years.