The superpower shoving match this week over the future of Taiwan illustrates why even peace-loving investors may want to consider adding defence stocks to their portfolios.
The new showdown between the United States and China comes on the heels of the Russian invasion of Ukraine in February. It underlines the world’s worrisome tilt toward armed conflict – or, at least, heated confrontation and snarling displays of military might.
As long as that trend continues, big U.S. defence contractors such as Raytheon Technologies Corp. RXT-N and Lockheed Martin Corp. LMT-N offer an attractive counterweight to more volatile sectors of the economy.
Both companies are reliably profitable. Both possess highly specialized armaments know-how that competitors can’t easily match. And both stand to benefit in the highly probable event that military spending surges in coming years.
The catch? Both are struggling right now with supply disruptions and worker shortages.
Even so, they offer reassuring stability at a time when economies appear to be slowing and nerves are strung taut. Each has outperformed a faltering stock market over the past year. Raytheon’s share price has gained about 9 per cent over that period, while Lockheed Martin’s stock has advanced about 19 per cent.
As galling as their current production bottlenecks may be, Washington is never going to offshore its defence spending. Few companies can count on such a reliable, deep-pocketed customer.
Lockheed Martin, the world’s largest defence contractor, would presumably be among the biggest beneficiaries of any surge in Washington’s military spending. It is in the final stages of negotiating a deal with the Pentagon for a new batch of F-35 combat jets that analysts expect to be worth about US$30-billion. More contracts for other advanced systems are likely to follow, according to a recent investor call.
Raytheon, too, is poised to benefit from arsenal restocking. It makes the Stinger and Javelin missiles, the latter in a joint venture with Lockheed. Both weapons have played a crucial role in helping Ukraine defend itself in recent months.
Raytheon also stands to benefit from a recovery in air travel. While the Massachusetts-based company derives about 60 per cent of its revenue from military sales, the other 40 per cent comes from commercial customers, primarily in the aerospace industry. Raytheon’s Pratt & Whitney division, for instance, makes and services airplane engines. If air travel continues to rebound in coming years, it will thrive.
The biggest problem for both Raytheon and Lockheed isn’t selling their goods, but producing them. Like many other U.S. companies, they are facing shortages of both key parts and key workers.
A month ago, Lockheed trimmed its sales and profit guidance for the year, blaming supply chain disruptions and the difficulties of attracting workers in one of the tightest labour markets in history.
Similarly, Raytheon chief executive Greg Hayes told analysts that the company has been hampered by the unexpectedly low number of workers that have returned to the company after being furloughed at the start of the pandemic. In previous downturns, three quarters of laid-off workers came back. This time around, only a quarter have.
Investors who look beyond these issues may detect the potential for better days ahead. If the U.S. economy slows in coming months, as many economists expect, unemployment will grow and workers will become easier to find. Meanwhile, increased military spending seems to be a near certainty, both in the U.S. and Europe.
Right now, both Lockheed and Raytheon seem reasonably valued. Their stocks enjoyed a boom immediately after Russia invaded Ukraine in February, but much of that initial excitement has since dissipated.
The two now trade at valuations that are roughly in line with their long-term averages – Lockheed at 16 times expected earnings for the next 12 months and Raytheon at 20 times. Lockheed pays a 2.6 per cent dividend yield, Raytheon, 2.3 per cent.
Held as part of a balanced portfolio, they offer insurance against both recession and military strife. Investors searching for peace of mind (if not peace itself) may want to take a closer look.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.