After a banner year for stocks, in which the S&P 500 gained a strong 29%, the outlook for 2020 is quiet and tame – analysts are predicting a yearly gain in the range of 3% to 5%. But that’s an average; not every market sector has to underperform for the average to dip that low. Defense stocks, the companies that specialize in supplying and servicing the Armed Forces, have outperformed the broader S&P 500 by 40% since November 2016.
This translates into serious money, especially in the US, the world’s largest spender on arms. US defense spending – over $700 billion in fiscal 2019 – is by far the largest in the world, easily surpassing the military budgets of the next seven largest defense spenders combined.
Spending of this magnitude makes a mark on the economy generally, and that can be seen in the recent growth of large defense contractors. In 2017 and 2018, aerospace giants Northrop Grumman and Lockheed Martin saw earnings grow by 61% and 155% respectively. The increases in the defense budget set in place by the Trump Administration are creating a boomlet for defense stocks.
That boomlet has attracted attention from investment firm Cowen, which outlined the prospects for the sector: “We see solid Q4’s for defense IT sector… [There is] potential for revenue acceleration & margin lift in 2020 offer valuation upside… Defense primes typically outperform in election years… services revenues are in an acceleration mode vs. relatively stable prospective 5-8% growth for the defense primes; and all of the companies have at least modest margin upside as revenue growth picks up…”
With that in mind, we’ve pulled three stocks – all flagged in the Cowen report for further growth – and used the TipRanks Stock Comparison tool to lay out their various strengths in a single chart.
KBR, Inc. (KBR)
This small-cap engineering, construction, and services company provides support to civil infrastructure, energy, government services, and petrochemical sectors worldwide. KBR operates mainly through two business divisions: Energy and Chemicals, and Government and Infrastructure. The company holds 15 logistic contracts to support US military operations in Afghanistan, and is the largest private contractor supporting US Government ops in Iraq. KBR is based in Houston, Texas.
In KBR’s most recent reported quarter, Q3 2019, it beat both the EPS and revenue forecasts. At the top line, revenues were a quarter-percent above expectations, at $1.43 billion. EPS was 2% better than expected, at 45 cents. KBR shares gained 95% in 2019.
As an added benefit for investors, KBR has used its success over the past decade to maintain a steady dividend. While not high – the payment is only 8 cents per quarter, and the yield is just 1.16% – the payment supplements the share appreciation, and guarantees an income stream for shareholders. And there is no worry that the company cannot sustain the dividend – the payout ratio, a comparison of the payment to the quarterly earnings – is only 17%.
Wall Street is sanguine about KBR stock. Writing on it for Cowen, 5-star analyst Gautam Khanna says, “We would be comfortable owning KBR into the print given the stock’s SOTP discount, but initial C20E EPS guidance at KBR may lag consensus, which could give investors an opportunity to add to positions. LOGCAP V is expected to ramp in C20 following a deluge of protests (assuming original award allocations remain intact), Freeport’s expected H1 FID bolsters the E&C outlook in C21+, and Ichthys arbitration may confer a cash windfall at some point over the next 1-2 years.”
Khanna maintains his $34 price target on KBR, supporting the Buy rating and implying an upside of 21% from current levels. (To watch Khanna’s track record, click here)
With 3 Buy ratings versus 1 Hold set in recent months, KBR shares get a Strong Buy from the analyst consensus. The average price target, $33.50, indicates a premium of ~20% from the $27.51 current trading price. (See KBR stock analysis at TipRanks)
Booz Allen Hamilton Holding (BAH)
Our next stock is a consulting firm, specializing is management and information tech. Based in McLean, Virginia, in the suburbs of Washington, DC, Booz Allen Hamilton is well-located to enter the government contractor niche. The company offers its services primarily to the US defense, intelligence, and civil government markets. It’s a lucrative business – BAH saw $6.7 billion in revenues in fiscal 2019, and has started 2020 with a 9% share gain.
Like KBR, BAH’s most recent reported quarter was solid. Fiscal Q2, reported in early November, showed above-expectation results in both earnings and revenues. EPS was strong, at 81 cents per share, beating the forecast by 15.7%. Revenues beat by less, 2.9%, and came in at $1.82 billion. That was 13% over the year-ago number. Forward guidance shows the company bringing in $7.28 billion for the current fiscal year, and predicts a full-year EPS of $3.07.
BAH’s 27-cent dividend annualizes to $1.08, and the company has been gradually raising it for the last 5 years, with three of the increases coming since 2017. The current payment gives a yield of 1.4%, nothing to write home about but in-line with bond yields. So, it’s an added incentive for a stock that is showing strong price appreciation.
5-star Cowen analyst Cai Rumohr describes BAH as one of his favorite defense stocks. He writes, “BAH offers potential for a Q3 EPS beat on a 10%+ sales gain… Dec Q book-bill may only be near nine-year average of 0.63x. But BAH should … FY20 guide with potential for organic growth near the top of its indicated 9-11% range and possible “color” on its plan to monetize IP.”
In line with his comments, Rumohr puts a Buy rating and a $92 price target on this stock, showing his confidence in an 17% upside. (To watch Rumohr’s track record, click here).
Ovearall, BAH gets a Moderate Buy from the analyst consensus, based on 7 ratings that include 4 Buys and 3 Holds. Shares are selling for $77.57, so the average target of $82 would suggest a modest upside of 4%. But, as Rumohr points out above, there may be room here for additional growth. (See Booz Allen’s stock analysis at TipRanks)
Science Applications International (SAIC)
Last on our list today is Science Applications International, another consulting firm. Like BAH, and a host of other government contractors, SAIC is based in NOVA, the Northern Virginia suburbs of Washington. The company provides applications and solutions in the scientific, engineering, and technology sectors for government services agencies. SAIC sees approximately $4.7 billion in annual revenues, and saw a 39% share price gain in 2019.
The most recent quarterly, reported in December, was not as kind to SAIC as it was to the companies above. Fiscal Q3 saw SAIC miss the EPS and revenue forecasts. Both numbers were strongly positive, however, and well above the year-ago figures. EPS came in at $1.39 per share, with top-line revenues of $1.63 billion. This compares well with the $1.35 and $1.18 billion from the year before. Looking ahead, analysts expect the company to continue seeing earnings growth – the forecast for the next quarter is $1.57 billion in revenues.
SAIC has been consistent in sharing out the profits with investors. The dividend has been maintained for the past 6 years, and was increased last year to 37 cents per share quarterly. That gives an annualized payout of $1.48 and a yield of 1.65%. A low payout ratio, just 26%, makes the dividend easily sustainable into the foreseeable future.
Cai Rumohr, quoted above, describes SAIC as a ‘wild card.’ He says of the stock, “EPS may slightly lag Street’s $1.34, but the stock has support from a peer-hi 9.0% cash flow yield. Moreover, book-bill should top 1.0x… These point to uptick in FY21 organic growth to ~4-5%… and SAIC’s robust pipeline of 2.5x bids outstanding/sales suggests continued award vigor in FY21.”
Rumohr raises his price target here to $105, backing his Buy rating. His new target suggests an upside potential of 16%. (To watch Rumohr’s track record, click here)
SAIC has only two recent analyst reviews, but both rated the stock a Buy. Shares are priced at $89.56, and the average target of $108.50 indicates room for 20% growth to the upside. (See Science Applications stock analysis at TipRanks.)