2 Defense Stocks That Could Rocket Higher
Aerospace and defense giant Raytheon Technologies (RTX 1.67%) and $1.7 billion-market-cap aerospace and defense welterweight AAR Corp (AIR 2.19%) are two companies at different ends of their sector's spectrum. Nevertheless, they are both attractive stocks trading at reasonable valuations with plenty of growth prospects. So here's a look at why both stocks are worth buying.
Not just commercial aerospace (although that's good too)
First up, both companies are good ways to play the ongoing recovery in commercial aerospace, and have been previously discussed in that context. However, it's time to focus on their defense businesses, which are both significant. For example, Raytheon's defense-focused segments, Raytheon Missiles & Defense (RMD) and Raytheon Intelligence & Space (RIS), generated almost 48% of Raytheon's sales in 2021. Meanwhile, AAR's government (primarily defense) business was responsible for 51% of the company's fiscal 2021 sales.
As a major supplier of aircraft engines and parts (Pratt & Whitney) and a wide range of aerospace components (Collins Aerospace), Raytheon is well set to participate in the multi-year recovery in commercial aerospace. Indeed, commercial aviation will drive the near-term improvement of the company.
However, it would be a mistake to leave the analysis there and ignore the defense business, not least because the stability of RIS and RMD carried the company through the dark period of severe COVID-19 lockdowns. In addition, both segments operate in areas of defense spending that have proved their value in the conflict in Ukraine. Moreover, management has spoken of the potential for an uptick in replacement orders in 2023 or 2024 for Stingers (portable air defense) and Javelins (portable anti-tank munitions) used in the conflict. While they are old equipment needing redesign, their eventual replacement provides a medium-term opportunity for Raytheon.
Moreover, the increased focus on the need for defense spending and modernization ties in well with Raytheon's emphasis on 21st-century defense solutions. Similarly, Russia's use of hypersonic missiles may well encourage interest in the hypersonic systems being developed by Raytheon and Lockheed Martin.
Raytheon's CEO Greg Hayes is already aiming for $10 billion in free cash flow (FCF) by 2025, driven by the commercial aerospace businesses. However, strengthening the company's medium-term growth prospects in its defense businesses may lead to improved earnings and FCF expectations and a subsequent boost for the stock.
The company provides a combination of aviation ($1.6 billion in fiscal 2021 sales) and expeditionary ($99 million) services. Aviation services involve providing commercial and government customers with parts, logistics & fleet management services, and maintenance, repair, and overhaul (MRO). Expeditionary services provide air transportable containers, tactical shelters, and air cargo pallets. By coincidence, and serving as an example of its work, AAR recently signed an exclusive distribution agreement with Raytheon's Collins Aerospace to distribute its de-icing and specialty heating systems to airlines, aircraft operators and MROs.
AAR's government-based business suffered a setback in 2021 with the withdrawal from Afghanistan. However, management hasn't stood still since then. A 10-year $365 million deal to support the USAF F-16 aircraft in Europe was signed in December, followed in February by a 10-year extension to provide component MRO for a company (IAMCO) responsible for maintaining NATO aircraft.
CEO John Holmes recently answered a question on whether he saw any potential increase in revenue coming as a consequence of the conflict. In response, he suggested that increased spending on sustaining defense fleets could benefit AAR's parts business. Meanwhile, the expeditionary services business could benefit from increased sales of shelters and containers to support troop movements. Finally, Holmes noted that AAR has a worldwide aviation support services (WASS) contract with the State Department, which could benefit from "increased diplomatic activity" due to the conflict. Trading at less than 17 times estimated FCF in 2024, AAR remains a good value.
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Article initially appeared on motleyfool.com
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