Valuation in the Aerospace and Defense Sector

The Aerospace & Defense sector makes for some great investments. The stocks discussed here are United Technologies Corp (UTX), The Boeing Company (BA), Lockheed Martin Corp (LMT), General Dynamics Corp (GD), Raytheon Company (RTN), Northrop Grumman Corp (NOC) and L-3 Communications Holdings Inc (LLL). All the stocks except BA are Dividend Contenders in David Fish’s CCC list; companies that have raised dividends consecutively for 10-24 years. BA saw a freeze in dividend raises from 2009 to 2011.
Each company discussed here has its own specialty and is the leader in manufacturing defense related products and services. I have not read enough about the sector to comment or recommend one stock or another based on the technology and business-outlook side of things. For now, I will simply be looking at the valuations and the financials/dividend history to compare the stocks. I recommended readers to do their own research before investing in any of the stocks discussed.The US spends a massive 3.8% of its GDP (numbers as of 2013) on military and defense budget. That amounts to about $640B – a number much larger than any other country on this planet. To put things into perspective, the military/defense budget of the next 10 highest spending countries need to be put together to get close to that number. Suffice it to say, that the defense contractors discussed here make for some juicy returns for your investment money.

Valuations

The current valuations of the stocks under questions are shown below.

United Technologies Corp (UTX)
United Technologies Corporation provides technology products and services to the building systems and aerospace industries worldwide. UTX is a conglomerate operating in six segments – Otis, UTC fire & security, Pratt & Whitney, Hamilton Sundstrand and Sikorsky. UTX has been raising dividends for 20 years in a row with 5-yr and 10-yr dividend growth rates (DGR) of 10.3% and 14.5% respectively.
UTX is probably the most diverse of the group, as the company is a conglomerate with defense being only one component of a massive corporation (defense revenue accounts for 21% of the company’s total revenue). UTX is also a DJIA component and the P/E valuation closely matches that of the index.
The Boeing Company (BA)
The Boeing Company, together with its subsidiaries, designs, develops, manufactures, sells, services, and supports commercial jetliners, military aircraft, satellites, missile defense, human space flight, and launch systems and services worldwide. The company operates in five segments: Commercial Airplanes, Boeing Military Aircraft, Network & Space Systems, Global Services & Support, and Boeing Capital. BA, after a freeze in dividend raises from 2009-2011, has started aggressively raising dividends since. Last year’s dividend raise was a whopping 50% and the 5-yr DGR currently stands at 8.18%.
Probably the most publicly known companies because of their commercial airline manufacturing business, BA is also a DJIA component and like UTX, has a fairly similar matching to the index – although the current P/E and P/B ratios are very high. With a Graham number of 50.97, BA is currently overvalued.

Lockheed Martin Corp (LMT)
Lockheed Martin Corporation, a security and aerospace company, is engaged in the research, design, development, manufacture, integration, and sustainment of advanced technology systems, products, and services for defense, civil, and commercial applications in United States and internationally. LMT is a dividend contender having raised dividends for 11 years in a row, with a 5-yr DGR of 21.2% and a 10-yr DGR of 23.5%.
Lockheed Martin is the highest grosser in the defense sector for the past few years and also counts defense spending as the biggest source of revenue at 95%. LMT is at the top-end of the scale with highest yield, highest payout ratio, highest 5-yr DGR. However, LMT also has the highest amount of debt totaling $6.15B (which is a debt/equity of 1.28). The company will probably not be able to keep up with the massive dividend increases going forward. With a Graham number of 57.28, LMT is currently overvalued.

General Dynamics Corp (GD)
General Dynamics Corporation operates as aerospace and defense company worldwide. Its Aerospace group designs, manufactures, and outfits business-jet aircrafts; provides aircraft services, such as maintenance, repair work, fixed-based operations, and aircraft management services; and performs aircraft completions for aircraft.  GD is a dividend contender having raised dividends for 23 years in a row, with a 5-yr DGR of 10.3% & 10-yr DGR of 13.3%.
GD is right in the middle of the pack for all valuations, but has stood the test of time – with the 23 years of dividend increases and will cross into the dividend champions list in two years, provided they keep the dividend raises coming.

Aerospace & Defense sector ranking based on revenue

Raytheon Company (RTN)
Raytheon Company develops integrated products, services, and solutions in the areas of sensing; effects; command, control, communications, and intelligence; mission support; and cyber and information security worldwide. It operates in four segments: Integrated Defense Systems; Intelligence, Information, and Services; Missile Systems; and Space and Airborne Systems. RTN is a dividend contender having raised dividends consecutively for 10 years; with a 5-yr DGR of 14.4% and 10-yr DGR of 10.4%.
Raytheon’s P/E, P/B, debt level, yield, payout ratio and DGR all are very agreeable and will need a closer look for an investment at current levels.

Northrop Grumman Corp (NOC)
Northrop Grumman Corporation provides systems, products, and solutions in aerospace, electronics, information systems, and technical service areas to government and commercial customers worldwide. The company’s Aerospace Systems segment designs, develops, integrates, and produces manned aircraft, unmanned systems, spacecraft, high-energy laser systems, microelectronics, and other systems and subsystems. NOC is a dividend contender having raised dividends consecutively for 11 years; with a 5-yr DGR of 10.9% and a 10-yr DGR of 12.7%.
Northrop Grumman also seems very attractively valued at current market levels. The company has very agreeable metrics such as P/E, P/B, debt level, yield, payout ratio and DGR.
L-3 Communications Holdings Inc (LLL)
L-3 Communications Holdings, Inc., through its subsidiary, L-3 Communications Corporation, provides command, control, communications, intelligence, surveillance, and reconnaissance (C3ISR) systems; aircraft modernization and maintenance; and national security solutions in the United States and internationally. The company operates in four segments: Aerospace Systems, Electronic Systems, Communication Systems, and National Security Solutions. NOC is a dividend contender having raised dividends consecutively for 11 years; with a 5-yr DGR of 13.8%.
The lowest yielder, but also the lowest payout ratio (at 28.4%) of the group provides for plenty of room for future increases. The company is also just a little higher than the Graham number (115.89) and is currently attractively priced.
For the risk averse investor, you can get exposure to all the stocks mentioned above by buying one of the following ETFs.

  • iShares US Aerospace & Defense ETF (ITA) – MER 0.44%, yield 1.52%
  • PowerShares Aerospace & Defense Portfolio (PPA) – MER 0.66%, yield 0.98%
  • SPDR S&P Aerospace & Defense ETF (XAR) – MER 0.35%,  yield 2.52%
What are your thoughts on the stocks mentioned? Do you own any? What are your thoughts/comments/concerns on them? Leave a comment below.
Full Disclosure: None. My full list of holdings are available here. 

8 thoughts on “Valuation in the Aerospace and Defense Sector

  1. R2R,

    Thanks for the information on these companies. I actually am starting to like Boeing as a contrarian play. It has been spending a lot of time in the Dow’s basement this year along with GE.

    MDP

    • I regret not adding LMT to my portfolio last year when I looked at it around $125 level. I added GE recently and surprisingly GE also wins a bit of defense contracts. That link from third image in my article shows that GE is ranked #20 in defense contractors and last year had $4B revenue from defense contracts.
      I still need to do a lot more research on each of the companies – but some of them seem at decent valuations.

      regards
      R2R

    • Its still a great company to invest in, but I doubt that they will be able to keep the dividends growing as they have been. Current valuations look better for GD, RTN, NOC and LLL. Still not sure which one to pick.

      Thanks for stopping by and the comment
      R2R

  2. I am a lil tentative in entering these sector stocks. I really dont know how long this war machine will last? Will the US defense budget get severely cut at some point? Will world conflicts cool? To me its very uncertain so that why I am pretty much staying away for now.

    • Hey A-G, those are the same questions Ive been asking myself. The US defense budget has seen some cutbacks lately, but considering the rising Russian tension and the tension with China always there, albeit on the backburner, I think that the spending will not be cut down. As much as we all wish it so, the war machine keeps churning. I still havent made up my mind – but I might invest in some of them as I also like that most of them specialize in civil and info tech defense – to deal and prevent with cyber attacks…what we will probably see a lot of, in the future.

      Thanks for the input…gives me food for thought
      R2R

  3. Hey R2R!
    I took a look at LMT a while ago and its numbers look pretty good. Especially dividend growth rate! However, I don’t feel comfortable buying company that is so dependent on the US government, which is why I didn’t do any further research.

    This sector is quite interesting, giving the fact that people have been fighting as long as we have existed and unfortunately that doesn’t seem to be changing.. Thanks for great overview of the sector!

    Regards,
    TDW

    • TDW, you are right – its almost become second nature in humans that we have a need to fight. With natural resources getting scarcer and the population expected to rise in the next few decades, the wars will continue, unfortunately.
      Thats a good point on the dependence on one country’s budget. I have to check on how much of the companies revenues come from different countries – and check if they are diversified. Im sure the lions share comes from the US, but it would be an interesting to know the distribution.

      LMT has done very well and as you can see from the charts, it is most dependent on defense spending (with 95% of the revenue coming from defense). Also, the div growth has been really aggressive and considering that their payout ratio is so high, I cant imagine them being able to keep the div growth in future years at the same rate.

      Thanks for the input
      R2R

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