Escalating geopolitical tensions worldwide has proven the importance of having a strong defense. The recent attack on Israel will likely drive nations to increase their defense budgets.
Given the industry’s long-term prospects, it could be wise to buy fundamentally strong defense stocks L3Harris Technologies, Inc. (LHX), OSI Systems, Inc. (OSIS), and Northrop Grumman Corporation (NOC).
Before diving deeper into their fundamentals, let’s discuss what’s happening in the defense industry.
The global defense industry is being shaped by increasing defense spending by developed and emerging nations, primarily for strengthening their air defense systems. Growing geopolitical instabilities and the evolving nature of warfare contribute significantly to the anticipated growth of the air defense system market worldwide.
Ukraine's war with Russia last year has underscored the need for countries to strengthen their military and air defense capabilities. In 2022, global military expenditures rose by 3.7%, reaching $2.24 trillion. Moreover, the recent attack on Israel by militant group Hamas will likely prompt nations to increase their defense spending.
U.S. defense spending is projected to reach $886 billion in 2023. Additionally, the Department of the Air Force has requested a year-over-year budget increase of 11.7%, totaling $194 billion. Also, the aerospace and defense market is anticipated to reach $1.08 trillion by 2027, growing at a 5.9% CAGR.
Moreover, technological breakthroughs are enhancing the effectiveness of missile and air defense systems. The integration of radar systems, artificial intelligence, and analytics has accelerated threat identification and interception, fundamentally reshaping the landscape of modern warfare and propelling the sector's growth trajectory.
Considering these conducive trends, let’s analyze the fundamentals of the three Air/Defense Services picks, beginning with the third choice.
Stock #3: L3Harris Technologies, Inc. (LHX)
LHX is an aerospace and defense technology company that provides mission-critical solutions for government and commercial customers worldwide. It operates through three segments: Integrated Mission Systems, Space and Airborne Systems, and Communication Systems.
On November 27, 2023, LHX announced an agreement under which an affiliate of TJC L.P. will acquire its Commercial Aviation Solutions (CAS) business for $800 million. The agreement involves a $700 million cash purchase and a $100 million earnout linked to financial targets. CAS provides services like pilot training, flight data analytics, avionics, and advanced air mobility products.
Christopher E. Kubasik, Chair and CEO at LHX, said, “Today’s announcement is consistent with our multi-year strategy to optimize our national security, technology-focused portfolio. Aligned with our capital allocation priorities, we plan to use the proceeds from this transaction to repay debt, which will accelerate our timeline to reach our debt leverage objective.”
On November 2, 2023, LHX secured an $80 million U.S. Navy contract to develop advanced electronic warfare (EW) systems for F/A-18 aircraft. The system enhances pilot protection with integrated threat detection across radio frequency bands. The innovative system, using a modular open systems approach, facilitates easy integration of new technology, saving time and reducing costs.
In terms of the trailing-12-month levered FCF margin, LHX’s 10.63% is 76.9% higher than the 6.01% industry average. Likewise, its 7.96% trailing-12-month net income margin is 31.2% higher than the 6.07% industry average. Furthermore, its 14.92% trailing-12-month EBITDA margin is 8.8% higher than the 13.72% industry average.
For the third quarter that ended September 30, 2023, LHX’s revenues from product sales and services increased 15.8% year-over-year to $4.92 billion. Its non-GAAP operating income rose 22.1% over the prior-year quarter to $210 million. In addition, its non-GAAP net income and non-GAAP EPS came in at $607 million and $3.19, respectively.
Street expects LHX’s EPS and revenue for the quarter ending December 31, 2023, to increase 1.3% and 15.7% year-over-year to $3.31 and $5.30 billion, respectively. Over the past three months, the stock has gained 14.8% to close the last trading session at $198.01.
LHX’s solid prospects are reflected in its POWR Ratings. It has an overall rating of B, which translates to a Buy in our proprietary rating system. The POWR Ratings assess stocks by 118 different factors, each with its own weighting.
It is ranked #21 out of 71 stocks in the Air/Defense Services industry. It has a B grade for Growth and Momentum. In addition to the POWR Ratings grades I’ve just highlighted, you can see LHX’s ratings for Value, Stability, Sentiment, and Quality here.
Stock #2: OSI Systems, Inc. (OSIS)
OSIS designs and manufactures electronic systems and components. It operates in three segments: Security, Healthcare, and Optoelectronics and Manufacturing.
On November 30, 2023, OSIS announced an $18 million contract with an international airport for its Security division. The deal involves supplying screening solutions like the RTT 110 explosive detection system, Metor Walk-Through Metal Detector, and Itemiser 5X explosive trace detection system. OSIS will also provide multi-year maintenance, service, and support.
On November 16, 2023, OSIS announced that its Optoelectronics and Manufacturing division received orders worth around $5 million to supply electronic assemblies to a prominent motion control and fluid technology OEM.
In terms of the trailing-12-month EBIT margin, OSIS’ 10.36% is 116.6% higher than the 4.78% industry average. Likewise, its 7.24% trailing-12-month net income margin is 230% higher than the 2.20% industry average. Furthermore, its 13.85% trailing-12-month Return on Common Equity is significantly higher than the 1.11% industry average.
OSIS’ total net revenues for the fiscal first quarter that ended September 30, 2023, increased 4.2% year-over-year to $279.21 million. Its non-GAAP net income grew 4.1% year-over-year to $15.56 million, and its non-GAAP EPS rose 4.6% over the prior-year quarter to $0.91.
Analysts expect OSIS’ EPS and revenue for the quarter ending December 31, 2023, to increase 46.6% and 23.2% year-over-year to $1.75 and $364.29 billion, respectively. It surpassed the Street EPS estimates in each of the trailing four quarters. The stock has gained 54.7% year-to-date to close the last trading session at $122.99.
OSIS’ POWR Ratings reflect strong prospects. It has an overall rating of B, translating to a Buy in our proprietary rating system.
It has a B grade for Sentiment. It is ranked #19 in the same industry. To see OSIS’ Growth, Value, Momentum, Stability, and Quality ratings, click here.
Stock #1: Northrop Grumman Corporation (NOC)
NOC operates as an aerospace and defense company worldwide. It operates through the Aeronautics Systems, Defense Systems, Mission Systems, and Space Systems segments.
On August 8, 2023, NOC announced the manufacturing of the first set of solid rocket motor cases for the Missile Defense Agency’s (MDA) Next-Generation Interceptor (NGI) program. This milestone demonstrates advancements in design and manufacturing, utilizing pathfinder motors for testing and integration operations.
NOC’s NGI Vice President Lisa Brown said, “Our experienced teams and cutting-edge solid rocket motor manufacturing technologies, backed by flight-proven processes, have enabled us to achieve several key milestones in rapid succession. With NGI’s mission to defend our homeland against incoming enemy threats, saving time and reducing risk is vital.”
In terms of the trailing-12-month EBIT margin, NOC’s 15.10% is 56% higher than the 9.68% industry average. Likewise, its 8.23% trailing-12-month levered FCF margin is 36.9% higher than the 6.01% industry average. Furthermore, its 0.88x trailing-12-month asset turnover ratio is 11.1% higher than the 0.79x industry average.
NOC’s total sales for the third quarter ended September 30, 2023, increased 9% year-over-year to $9.78 billion. Its operating income rose 20.4% year-over-year to $1.02 billion. The company’s net earnings increased 2.4% year-over-year to $937 million. Additionally, its EPS came in at $6.18, representing an increase of 4.9% year-over-year.
For the quarter ending December 31, 2023, NOC’s revenue is expected to increase 4% year-over-year to $10.43 billion. Its EPS for the quarter ending March 31, 2024, is expected to increase 5.3% year-over-year to $5.79. It surpassed the consensus EPS estimates in each of the trailing four quarters. Over the past three months, the stock has gained 10.6% to close the last trading session at $476.61.
NOC’s strong fundamentals are reflected in its POWR Ratings. It has an overall rating of B, translating to a Buy in our proprietary rating system.
It has a B grade for Momentum and Stability. It is ranked #15 in the Air/Defense Services industry. In total, we rate NOC on eight different levels. Beyond what we stated above, we also have given NOC grades for Growth, Value, Sentiment, and Quality. Get all the NOC’s ratings here.
What To Do Next?
43 year investment veteran, Steve Reitmeister, has just released his 2024 market outlook along with trading plan and top 11 picks for the year ahead.
NOC shares were unchanged in premarket trading Wednesday. Year-to-date, NOC has declined -11.21%, versus a 21.27% rise in the benchmark S&P 500 index during the same period.
About the Author: Abhishek Bhuyan
Abhishek embarked on his professional journey as a financial journalist due to his keen interest in discerning the fundamental factors that influence the future performance of financial instruments.
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