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Stocks with a fighting chance?
With conflict on the rise, defense contractors have rallied. Is the run over?
April 3, 2002: 3:46 PM EST
By Jake Ulick, CNN/Money Staff Writer

NEW YORK (CNN/Money) - These are good times for the companies that make the tools of war.

Defense contractors General Dynamics, Raytheon and Northrop Grumman pump out press release after press release on their latest multimillion-dollar deal to build aircraft, rockets and tanks.

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President Bush, who declared war on terrorism, wants Congress to okay the biggest jump in defense spending in 20 years.

And shares of defense and aerospace companies have surged since Sept. 11. Without Boeing, United Technologies and Honeywell, the Dow Jones industrial average would not be higher on the year.

"We have more and more brush fires needing to be taken care of," said Ivan Obolensky, who covers aerospace and defense for Shields & Co, referring to rising military activity. "There are brush fires all over the world."

But the country's shift to war following a decade of peace is not a compelling reason to pour funds into these stocks now, said Robert Friedman, Standard & Poor's aerospace and defense analyst.

"The industry is much more volatile and less predictable than investors believe," said Friedman.

The seemingly lucrative defense contracts are often amended, Friedman said. Congress, facing demands on the solvency of Social Security, may not be willing to make the big spending increases that Bush wants. Or, lawmakers may be more inclined to pour money into much-anticipated raises for the military, not weapons. And many of the defense projects which are poised for approval, like missile defense, are low-margin business, according to Friedman.

"Given current prices, investors in defense stocks may be setting themselves up for disappointment down the road," he said.

There haven't been many disappointments yet. Shares ofLockheed Martin (LMT: down $0.29 to $58.62, Research, Estimates), the Bethesda, Md.-based maker of the Joint Strike Fighter, are up 74 percent from their 52-week low.

Raytheon (RTN: down $1.62 to $40.13, Research, Estimates), the Lexington, Mass.-based maker of the Tomahawk missile, is up 71 percent from its 52-week low.

Northrop Grumman (NOC: down $0.45 to $113.55, Research, Estimates), the Los Angeles-based maker of the B-2 stealth bomber, is 50 percent higher than it was at its 52-week low.

And after rallying in its February IPO,Integrated Defense Technologies (IDE: up $0.35 to $29.00, Research, Estimates), a provider of technology to the U.S. military, has not slowed down.

Investors wanting to buy a basket of these stocks have only one choice: Fidelity's Select Defense and Aerospace Fund, which is up some 13 percent this year and is heavy in Northrop, General Dynamics (GD: down $0.75 to $94.15, Research, Estimates) and Lockheed.

Defense contractors had plenty of problems in the late 1990s, when Congress was cutting defense budgets. These may be different times.

The Bush administration is requesting $396.1 billion for the military in fiscal year 2003, up 13 percent from current levels, according to the Center of Defense Information, the largest the boost in 20 years.

But "the jury is out over whether Congress is amenable to big increases in budgets" S&P's Friedman said.

Yet the good news pours in. Northrop Grumman Monday said it won its second contract in two weeks to develop surveillance capabilities of the high-flying Global Hawk pilotless reconnaissance aircraft that generated headlines during the war against Afghanistan.

And Raytheon Wednesday said it should meet this year's profit targets and grow earnings by as much as 15 percent on average over the next five years.

For investors, it may come down to how much of the good news is factored into these stocks. Take United Technologies, the No. 2 company in the sector by sales. Up 13 percent this year, it trades at about 19 times next year's profit estimates. Not expensive, compared to, say, Microsoft (MSFT: down $1.47 to $55.83, Research, Estimates), but pricey relative to Philip Morris (MSFT: down $1.43 to $55.87, Research, Estimates).

Obolensky, the Shields & Co analyst, says it's not too late to buy defense stocks. He likes Northrop, General Dynamics and United Technologies -- in that order.

And though he's less bullish on Raytheon, Boeing and Lockheed, the sector, he said, is promising.

"It's the only way to go today," Obolensky said.  Top of page