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Different
In One Important Way |
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Not
that their large-cap counterparts didn't do it, but the small and
micro cap defense stocks have started to fly high again this week.... a
move that we hinted at (and the reason we initiated the Small/Micro Cap
Defense Index) back on February
21st. On the other hand, the micro cap defense names do differ
with the large cap defenses stocks in one major way..... they're not
stupidly overbought right now.
That's the blunt
way of saying the small and micro cap names in the bunch still have some
value to be factored into their stocks' price in the near future. The large
caps,
on the other hand, may be running out of steam as the Boeing (BA) euphoria
[the lone bidder in a tanker contract deal] becomes a little tired.
In fact, a quick
glance at a tanker contract reality may turn you off Boeing completely.
At the same time, some interesting news from the diminutive end of the
defense stock spectrum is something worth exploring.
European manufacturers
are crying foul over the way the bidding system eliminated all other contenders
except for Boeing in the Pentagon's contest to award a lucrative $35-$40
billion aerial tanker contract (estimated to be worth about $3 to $4 billion
per year over a ten year span).
 The
complaints are likely to fall on deaf ears, however. The contract will
be
Boeing's barring a bizarre miracle stemming from an EADS re-entry into
the bidding now that the deadline has been extended, or - and this isn't
a joke - a successful bid from Russia's state-owned firm, United Aircraft
Corporation (or UAC). Both are long shots at this point.
As such, BA
shares have been on the rise, gaining 33% for the year so far. Most of
the gain has materialized in the last month or so, after EADS/Airbus/Northrop
dropped out of the race.
Yes, $3 billion
per year is a ton of money for the average person to earn in a year. It's
barely pocket changes for Boeing though.
Most investors
understand Boeing's got $3 billion or more annually on the line here. What
most investors don't understand, however, is that Boeing generates
about $68 billion in revenue on an annual basis. Simple math tells us that
the
contract would only mean about a 4.4% bump in the company's sales figures.
Not that it's too small of a figure to work towards, but does a 4.4%
increase in revenue justify a 33% increase in a stock's price?
When
put in those terms, most investors' enthusiasm tapers quite a bit.
And don't be
fooled. While the federal government can be wasteful at times, military
contracts can end up being grueling and expensive for the contractor. Indeed,
this may end up being some of the least profitable revenue Boeing has seen
in a while, now that the Pentagon knows the tanker deal is being scrutinized
from all angles.
Bottom line?
There's
apt to be much less investment opportunity than assumed here.
As for the smaller
defense contractors that finally came alive this week....
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Our
Small/Micro Cap Defense Index |
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One could certainly
argue that the AMEX defense Index (DFI) and all the large cap defense names
that it represents have bullish momentum right now. But, that momentum
also means the group is carrying a major 'overbought' risk.
 On
the other hand, our Small/Micro Cap Defense-Only Index is still
well under January's highs, and under 2009's highs for that matter.
Yet, these names are also the uncovered opportunities stemming from yet-another
bloated military budget for the coming year [an idea we discussed in
detail back on February
16th]. Considering the recent strength exhibited from this group
though, the secret may be spreading now - the group is rolling again.
Not that each
and every stock in the index has posted 'news' since our last look, a few
recent events do need to be passed along as affirmation of the theme.
Here's the latest from its constituents:
Orbital Sciences
(ORB) - Orbital Sciences will be buying General Dynamics' (GD) satellite
unit for $55 million, which will add about that much each year in revenue,
and a little more each year in earnings. The acquisition, however, opens
a door to much more business.
FLIR Systems
(FLIR) - Benchmark Research initiates coverage on FLIR as a 'buy',
despite muted growth last year.
AeroVironment
(AVAV) - After missing on earnings last quarter and lowering full-year
guidance, one would expect AVAV shares to sink. But, the non-movement following
the news suggests the downside was already priced in. As we mentioned a
month ago, the proposed military budget specifically calls for more unmanned
aircraft; AeroVironment continues to be a potential surprise.
CPI Aerostructures
(CVU) - Last quarter's results (which came out Tuesday) say it all....
a 38% increase in revenue, a 71% increase in pre-tax income, and a 66%
increase in per-share earnings. The company anticipates revenue of around
$50 million in 2010, versus 2009's $43.9 million.
Alliant Techsystems
(ATK) - JP Morgan upgraded Alliant to an 'overweight' on Tuesday.
You don't have
to read in between the lines to deduce a clear message that these companies
are doing quite well despite their size. Better still, their stocks
are starting to get traction again - particularly now that we're
seeing upgrades and bullish coverage on a few of these names. Some large
cap defense names would be (and should be) envious.
So, consider
this a reiteration of our original bullish call on the small and micro
cap defense names.
Also, don't
forget to add Global Defense Technology (GTEC) to the mix. It's
been excluded from the index for the time being because its limited trading
history hinders the construction and maintenance of our index. It's a great
defense name though, and undervalued by most standards. The forward-looking
P/E is a modest 11.5.
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Updated: 8:15 pm PDT (03:15 GMT), November 2, 2010
