DeAnne
Mike CrowlContinued Growth Expected for Defense Companies in 2006
February 9th 2008 01:04
S. Michael Stolack
Companies involved with defense and homeland security have seen tremendous gains in the past six years. In fact, the SPADE Defense Index (AMEX: DXS), a financial benchmark tracking the sector has beaten the S&P 500 for six straight years. In five of those years, the gain was by more than 10% annually.
Although the streak started back in 2000 when the market was undergoing a correction, the obvious drivers have been the War in Iraq and the War on Terrorism following the September 11, 2001 attacks.
With the War in Iraq appearing to wind down in 2006, and other budget pressures, analysts are forecasting that the FY-07 budget to be proposed by the White House in the February timeframe, will show reductions on the order of $30 billion in the amount allocated to defense.
The question for investors is, 'has this run past them by'?
Results by the largest defense companies in 2005 were decidedly mixed, although each achieved positive gains that outperformed the S&P500. While Boeing (NYSE: BA) gained 35.7%, United Technologies (NYSE: UTX) gained 8.2%, Honeywell (NYSE: HON) 5.2%, Lockheed Martin (NYSE: LMT) 14.5%, General Dynamics (NYSE: GD) 9.0%, Northrop Grumman (NYSE: NOC) 10.6%, and Raytheon (NYSE: RTN) 3.4%.
In 2006, analysts are predicting gains by the large companies on the order of 3-5% with smaller, more specialized firms and those involved with homeland security, potentially seeing 10-12% growth.
Investors looking at the sector should realize five important trends:
1. A budget decline is not necessarily a decline in revenues. Forecasts are predicting a $30 billion decline in the defense spending but this is a decline from the almost $90 billion in growth already approved -- leading to a 'real' net game of nearly $60 billion over the next five years.
2. The proposed budget is not that important. This is always a lot of talk in Congress and Washington DC in general about what programs to cut or downsize. While the markets may move based on the discussion, from a company perspective, at the end of the day all that matters is what the President signs into law.
3. Outsourcing is on the rise. Much of the defense budget is devoted to operations, housing, medical services, and military salaries. Over time, the range of services and activities provided by the private sector for the military has been increasing. Private companies have been getting contracts to take on greater responsibility in operations as well as even helping the Marines guard U.S. embassies around the world.
4. The Homeland Security and space markets are growing. Since 2002, the budget for the Department of Homeland Security has nearly doubled to $40 billion a year and it is politically unlikely that this trend will stop. Can you picture a candidate running a platform that reduces spending on homeland security getting enough votes to win? Likewise, commercial services utilizing satellites, such as GPS positioning systems, communications networks, and television and radio are on the rise. According to the '2005 State of the Space Industry' outlook published by the International Space Business Council, this activities will add more than $50 billion in revenues by 2010.
5. The defense sector is well diversified. Although many still tend to think of the defense sector as tanks, ships, planes, and missiles, the sector has undergone a dramatic shift in recent years, making use of a number of leading edge technologies including battlefield visualization, network centric warfare, ceramic armor, and information technology. Combined with activities involved with border monitoring and data processing, biometric technologies, and satellite services offered to the commercial sector and related business lines such as the manufacture of commercial aircraft, the defense sector as defined by the SPADE Defense Index reflects a diverse basket of activities that can better weather a defense spending downturn than a pure play would suggest.
They say that past performance is not indicative of future gains, but one is hard pressed to argue against a trend that reflects the changing nature of the world.
Companies involved with defense and homeland security have seen tremendous gains in the past six years. In fact, the SPADE Defense Index (AMEX: DXS), a financial benchmark tracking the sector has beaten the S&P 500 for six straight years. In five of those years, the gain was by more than 10% annually.
Although the streak started back in 2000 when the market was undergoing a correction, the obvious drivers have been the War in Iraq and the War on Terrorism following the September 11, 2001 attacks.
With the War in Iraq appearing to wind down in 2006, and other budget pressures, analysts are forecasting that the FY-07 budget to be proposed by the White House in the February timeframe, will show reductions on the order of $30 billion in the amount allocated to defense.
The question for investors is, 'has this run past them by'?
Results by the largest defense companies in 2005 were decidedly mixed, although each achieved positive gains that outperformed the S&P500. While Boeing (NYSE: BA) gained 35.7%, United Technologies (NYSE: UTX) gained 8.2%, Honeywell (NYSE: HON) 5.2%, Lockheed Martin (NYSE: LMT) 14.5%, General Dynamics (NYSE: GD) 9.0%, Northrop Grumman (NYSE: NOC) 10.6%, and Raytheon (NYSE: RTN) 3.4%.
In 2006, analysts are predicting gains by the large companies on the order of 3-5% with smaller, more specialized firms and those involved with homeland security, potentially seeing 10-12% growth.
Investors looking at the sector should realize five important trends:
1. A budget decline is not necessarily a decline in revenues. Forecasts are predicting a $30 billion decline in the defense spending but this is a decline from the almost $90 billion in growth already approved -- leading to a 'real' net game of nearly $60 billion over the next five years.
2. The proposed budget is not that important. This is always a lot of talk in Congress and Washington DC in general about what programs to cut or downsize. While the markets may move based on the discussion, from a company perspective, at the end of the day all that matters is what the President signs into law.
3. Outsourcing is on the rise. Much of the defense budget is devoted to operations, housing, medical services, and military salaries. Over time, the range of services and activities provided by the private sector for the military has been increasing. Private companies have been getting contracts to take on greater responsibility in operations as well as even helping the Marines guard U.S. embassies around the world.
4. The Homeland Security and space markets are growing. Since 2002, the budget for the Department of Homeland Security has nearly doubled to $40 billion a year and it is politically unlikely that this trend will stop. Can you picture a candidate running a platform that reduces spending on homeland security getting enough votes to win? Likewise, commercial services utilizing satellites, such as GPS positioning systems, communications networks, and television and radio are on the rise. According to the '2005 State of the Space Industry' outlook published by the International Space Business Council, this activities will add more than $50 billion in revenues by 2010.
5. The defense sector is well diversified. Although many still tend to think of the defense sector as tanks, ships, planes, and missiles, the sector has undergone a dramatic shift in recent years, making use of a number of leading edge technologies including battlefield visualization, network centric warfare, ceramic armor, and information technology. Combined with activities involved with border monitoring and data processing, biometric technologies, and satellite services offered to the commercial sector and related business lines such as the manufacture of commercial aircraft, the defense sector as defined by the SPADE Defense Index reflects a diverse basket of activities that can better weather a defense spending downturn than a pure play would suggest.
They say that past performance is not indicative of future gains, but one is hard pressed to argue against a trend that reflects the changing nature of the world.
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