New Tensions May Benefit Defense Contractors

By Joseph Nguyen | May 25, 2010 AAA

When you hear of sin stocks, people are usually referring to stocks profiting from our human vices - such as gambling, booze, narcotics and sex. But perhaps the biggest 'sin' stocks of them all, that isn't typically mentioned with this group, may be business' that profit from war. Defense contractors and Arms manufacturers typically see their profits correlated with the level of tension and conflict between nations, and so investors looking to invest in these stocks may be especially interested in the recent military activity in the Persian Gulf.

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Iranian Intensification
According to political analysis site Debka.com, the Obama administration is beefing up its military presence around Iran by sending additional carrier groups to the waters surrounding the country. Currently there is only one U.S. carrier off the shores of Iran, but this new buildup will increase the number of U.S. carriers to two with an additional four U.S. warships on the way, as well as a German warship and 6,000 marines. With Iran's history of defiance towards the West, I anticipate a strong reaction by Iran in response to this massive show of force off the Iranian coast.

In addition to the sea, it appears the U.S. is also increasing military infrastructure on land around Iran. Bloomberg reported on Friday that the Pentagon is expanding and upgrading an airbase just outside Iran's border. The base is being upgraded to support operations in Afghanistan, however its proximity to Iran leads some analysts to speculate it could likely be used to monitor Iran's activities.

Who Will Benefit?
If this escalation of military presence provokes Iran in an adverse way, defense contractors could stand to profit. The top U.S. defense contractors (listed on major exchanges) saw their stocks rise as the war in Iraq started in 2003, and could see a similar boost should the Iran situation escalate further. With that said, some of the biggest U.S. defense contractors to keep an eye on are listed below:

Top 7 Defense Contractors Ticker P/E (ttm)
Lockheed Martin Corp. LMT 10.74
Northrop Grumman NOC 11.75
Boeing Co. BA 38.93
General Dynamics Corp GD 10.85
Raytheon Co. RTN 10.82
United Technologies Corp. UTX 15.55
L-3 Communications Holdings LLL 10.69

Lockheed Martin Corp.
Lockheed Martin has typically been the biggest recipient of contracts handed out by the Department of Defense, followed closely by Boeing and Northrop Grumman. Lockheed's first-quarter report in 2010 generally beat analyst expectations across the board. The company reported EPS of $1.45, which was above consensus estimates of $1.34, and which continues the trend of positive earnings surprises. Also, of note was the company's increase in free cash from $1.1 billion in Q1-2009 to $1.5 billion in the most recent quarter - which was the highest level of cash generated for a quarter in Lockheed's history.

Bottom Line
Arms and munitions is an out-of-favor sector in many people's eyes and has been so for a long time - which may explain the relatively low valuations for this sector. But within the sector, it appears that the top contractor, Lockheed, also trades at a discount to its peers that may be worth looking into. (For related reading, take a look at Sinful Investing: Is It For You?)

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