Defense Stocks Are Alive and Well

06/13/2011 9:00 am EST

Focus: STOCKS

George Putnam

Editor, The Turnaround Letter

With Congress aggressively debating budget cuts, defense stocks have been one of the worst performing industry groups over the past year. However, investors may have overreacted, making many of the stocks in the defense sector good values, notes George Putnam III of The Turnaround Letter.

Although the mood in Washington may not seem to favor defense stocks, geopolitical realities do.

The Middle East and Northern Africa may have been getting most of the recent headlines, but instability is hardly limited to those areas. Parts of Sub-Saharan Africa, the Indian subcontinent, and the former Soviet republics could all provide flashpoints that will require US military intervention at some point in the next few years.

Also, the trend is toward high-tech (and expensive) armaments that require fewer American soldiers on the ground in hostile territory.

While politics is always hard to handicap, many of the defense stocks are trading at very attractive valuations. The companies discussed below trade at an average forward-looking price-to-earnings ratio of 10.4, compared to 13.4 for the S&P 500 as a whole.

Moreover, most of these companies boast strong financials, and many pay a generous dividend.

Curtiss-Wright (CW)
This firm’s defense activities, targeting primarily naval operations, are experiencing growth.

New opportunities with submarines and aircraft carriers are offsetting terminations in other programs. Management continues to invest in the sector, particularly in electronics, to serve intelligence, surveillance, and reconnaissance applications.

In addition, some of Curtiss-Wright’s non-defense businesses—such as flow/motion controls and metal treatments used by the auto and aerospace industries—have rebounded along with the general economy.

Though revenues and earnings slipped during the recession, they have since rebounded. However, the stock continues to trade below its highs of 2009 and 2010.

Ducommun (DCO)
This concern provides components and assemblies for the commercial and military aerospace markets, and engineering services to missile and space programs.

Top-line results have been under pressure, due largely to weakness in demand for its military-helicopter products and services. Operations, though, have been solidly profitable.

The recent acquisition of LaBarge will significantly increase the company’s exposure in aerostructures and electronics, thus brightening Ducommun’s long-term prospects.

GenCorp (GY)
This company’s history dates back to 1915, when it was as a tire & rubber company, but today it is a niche player in the market for propulsion systems used in defense and space applications, as well as armament systems for tactical weapons.

The company also owns 12,000 acres in the Sacramento area that are arguably not fully reflected in the current stock price.

The firm’s financials are decent, though not outstanding. A new CEO, as of January 2010, appears to be making progress in focusing the company on its growth opportunities.

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