Feb 252010

(hyperlink this to the other discussion re investment in “defence” stocks)

Many thanks to Blake who writes: 

This Globe & Mail article illustrates the power behind the industrial/military alliance, and perfectly defines why you are right. 


Using defence stocks to bolster your portfolio 


Lt. Col. James Hecker flies over Fort Monroe Virginia before delivering the first operational F/A-22 Raptor to its permanent home at Langley Air Force Base, Va., in May 2005. This was the first of 26 Raptors to be delivered to the 27th Fighter Squadron. U.S. Air Force 

Military spending is still on the rise, and the stocks of companies that make munitions and other war-related items have been strong 

Published on Wednesday, Feb. 24, 2010 8:56AM EST;   Last updated on Wednesday, Feb. 24, 2010 6:59PM EST 

The thesis:

The ultimate defensive investment may be defence stocks. 

The rationale: 

Spending on defence is more a function of government priorities in the area of national security. It is not necessarily tied to economic cycles. Defence stocks may thus offer one way to make a portfolio less subject to economic fluctuations. 

Moreover, Mr. Katsoras and Mr. Fournier expect the global trend toward higher military expenditures will continue. The next section highlights some of the main points in their argument that the defence industry should experience growth in the years ahead. 

The background: 

World military spending has been on the rise this decade, climbing to a record level of $1.46-trillion (U.S.) in 2008. That is an increase of 45 per cent since 1999, according to the inflation-adjusted figures published by the Stockholm International Peace Research Institute (SIPRI). 

Reasons for the escalation are offered by National Bank Financial analysts, Angelo Katsoras and Pierre Fournier, in their February research report The Military Industry and Global Instability: 

•economic growth increases the ability of emerging countries to arm;

•the United States is conducting a “war on terror;”

•there’s an increasing number of “geopolitical hotspots.” 

Defence stocks as growth stocks:

Economic growth is increasing the capacity of emerging countries to buy weapons and expand their armed forces. In fact, the fastest growth in military spending is now in the developing world. 

According to SIPRI estimates, China has increased military spending by 194 per cent from 1999 to 2008, and is now the second biggest buyer with a 5.8-per-cent global share. Other big hikes have occurred in Russia (173 per cent), Saudi Arabia (81 per cent), South Korea (51.5 per cent), India (44 per cent), and Brazil (30 per cent). 

The emerging world is not without its tension spots. As economies expand, there are increasing concerns about protecting ports, shipping lanes, air space and access to critical materials. Moreover, there are still old rivalries and unresolved border disputes between Russia, Japan, China, India and Pakistan, note Mr. Katsoras and Mr. Fournier. 

Tensions are also rising between newly assertive emerging countries and the United States. In particular, China and the U.S. are becoming more strident in their disagreements over trade, currencies, protectionist measures, Taiwan and exiles such as Tibet’s spiritual leader, the Dalai Lama. 

Rearmament programs in the developing world are having a contagion effect. When one country commences a program to build up its capabilities, neighbouring countries feel compelled to follow suit. In short, there is a potential for regional arms races.

Looking at other venues, the U.S. is engaged in a war on terrorism, which has led to incursions into Iraq and Afghanistan. It is also beefing up homeland security. Meanwhile, tensions in the Middle East are approaching the boiling point due, in no small part, to suspicions that Iran is attempting to develop nuclear weapons. 

Investment opportunities: 

Since the developing world is where growth in military spending is likely to be greatest, one area to consider for investing purposes is U.S. defence suppliers with significant exposure to the developing world. Two with strong global presences are Lockheed Martin Corp. (LMT-N76.93-0.63-0.81%) and Raytheon Corp. (RTN-N55.83-0.34-0.61%) 

Also noteworthy are suppliers of equipment and weapons for local, unconventional, and terrorist threats. Some examples are DigitalGlobe Inc. (DGI-N23.291.607.38%) (satellite surveillance), Raytheon Corp. (interceptors of short- and medium-range missiles), and L-3 Communications Holdings Inc. (LLL-N90.84-0.49-0.54%) (unmanned aerial vehicles and body/luggage scanners). 

The U.S. defence industry is one of the few in America with a competitive edge in world markets. It currently accounts for over 75 per cent of global weapons exports in 2008. 

Spotlight on Lockheed Martin: 

In their report, Mr. Katsoras and Mr. Fournier single out Lockheed Martin, which trades at about $77 (U.S.), as “one example of a U.S. defence company with significant exposure to developing markets, which account for 25 per cent of its sales.” Contract wins in recent months include: 

•missile defence system for the United Arab Emirates, worth $7-billion;

•$842-million agreement with Morocco for F-16 jets;

•sale of two-dozen F-16 jets to Egypt for $3.2-billion. 

Recently released financial results for the company’s fiscal year (ending Dec. 31) were strong. The Bethesda, Md.-headquartered company generated $3.2-billion in cash from operating activities, and finished the year with cash and equivalents of $2.4-billion. Long-term debt stood at $5.1-billion. 

Revenues rose six per cent to $45.2-billion, during a year of recession. Earnings came in at $7.78 per share, ahead of consensus estimates. And management raised guidance for fiscal 2010 earnings per share to the $7.15 to $7.35 range. The order backlog at year end registered $78-billion. 

“The reason to own Lockheed Martin stock is that it may have the strongest dividend in the market at this time,” declares Associated Content contributor, Ken Van Gogh. Following last year’s increase in its quarterly dividend to 63 cents per share, the annual dividend yield is now close to 3.3 per cent. 

This dividend is financed by about a third of free cash flow, which is a very low payout ratio. On top of this, the dividend has been increased every year since 2002, and now stands 450 per cent higher. 

In another sign of financial strength, Lockheed Martin is returning cash to shareholders through a share-repurchase program. During fiscal 2009, the number of outstanding shares was reduced, from 400 million to 382 million. 

Risks to the big picture:

There are a number of risks that could undermine the positive outlook for defence stocks. They include: 

•an early U.S. withdrawal from Iraq and Afghanistan;

•a heavily indebted U.S. government further cuts defence spending;

•a slowdown in the growth of emerging economies. 

However, Mr. Katsoras and Mr. Fournier believe projections of early withdrawals from Iraq and Afghanistan are too optimistic. In fact, insurgencies in these countries are gathering momentum and the U.S. is increasing deployments to the region. 

In addition, they don’t see the financially strapped U.S. government cutting back on defence. The world is no where near the halcyon state that followed the end of the Cold War. America still faces many geopolitical threats. Having one or more flare up, (for example, another terrorist incident) especially keeps the focus on national security.

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