A good barometer of where defense stocks are going has always been the temperature of global geopolitical tensions. And the heat’s been on the rise for several years, as measured by global military expenditure.
In 2019, global military expenditure was $1.917 trillion. That increased to $1.981 trillion in 2020, the highest level since 1988, growing 9.3% higher from 2011. I believe that this spending trend is here to stay and it makes defense stocks attractive.
Recently, the International Monetary Fund also warned that there are growing signs of poverty, unrest and geopolitical tensions. With the Taliban taking control of Afghanistan, there is an additional concern in emerging Asia. Further, tensions between China and U.S. have sustained. The Middle East also remains a hotbed of conflict with Israel and Iran being the current focus of attention.
Given that there are several nuclear powers engaged in conflict, a full-fledged war seems unlikely. However, countries will continue to ramp-up their defense capabilities.
It therefore makes sense to consider exposure to defense stocks. It’s also worth noting that the defense sector is relatively immune to economic shocks. Even with the pandemic, the global military expenditures increased. This makes defense stocks attractive in any economic scenario.
Let’s talk about seven defense stocks that are worth considering for the medium to long term.
Rada Electronic Industries (RADA)
Let us start with a defense stock that seems to be flying under the radar and looks promising for the long-term. In the last 12-months, shares of Rada Electronic Industries have trended higher by 52%. However, I would not be surprised if RADA stock delivers multi-fold returns in the next few years.
As an overview, Rada is a defense-technology company with a focus on tactical radars. The company believe that the total addressable market for tactical radars is in excess of $6.0 billion. Therefore, there is ample scope for growth.
Top-line growth has already been robust for the company. For 2020, Rada reported revenue growth of 72% to $76 million. For the current year, the company has guided for revenue of $120 million.
It’s worth noting that the company had an order intake of $56 million for the first half of 2021. On a year-on-year basis, order intake was 37% higher. If this momentum sustains, Rada is well positioned for healthy top-line growth in the coming years.
Recently, Rada and Alpha Design Technologies signed an agreement for a joint venture in India. That country is ramping-up defense expenditure as tensions continue with China and Pakistan.
Rada believes that it has a market share of around 10% in the tactical radar segment. However, over the next five years, the company is targeting a market share of 50%. Given the growth trajectory and the market size, RADA stock is worth holding in the portfolio.
AAR is another interesting name among small-cap defense stocks. Even after an upside of 65% in the last 12-months, AIR stock looks attractive at a forward price-to-earnings-ratio of 13.8.
As an overview, AAR is a provider of aviation service to the commercial and government sector globally. This includes MRO service and parts supply and integrated solutions. In 2020, the company reported 38% of revenue from the government sector. However, sales to
government and defense sector increased to 51% in 2021.
This is an indication of the company’s focus, which is likely to deliver results in the long-term. With the downturn in commercial aviation, the company’s investment is likely to remain high in the defense segment. Importantly, as defense revenue growth, the company is positioned for relatively higher EBITDA margin. Recently, DefenseNews included the company among the top-100 defense companies.
The Pentagon is a key client and the company has made inroads in the defense sector in Japan, Netherlands and U.K. Clearly, with international presence, there is a big addressable market for the company.
Overall, AIR stock looks good for further upside after some consolidation. As operating cash flows increase, the company will be positioned for further investment and expansion.
Kratos Defense & Security Solutions (KTOS)
Kratos Defense is among the smaller names in the defense sector. However, KTOS stock holds immense potential in the long-term. In the recent past, the stock has been in a correction mode and this provides a good accumulation opportunity.
The company specializes in unmanned systems, satellite communications, cyber security/warfare, microwave electronics and missile defense, among others. Additionally, the company is involved in the next generation turbo jet and turbo fan engine development.
For Q2 2021, the company reported revenue growth of 20.4% on a YoY basis to $205.1 million. It’s worth noting that the company’s unmanned systems segment revenue surged by 43.6% to $60.3 million.
Eric DeMarco, Kratos’ president and CEO, has also guided for strong growth in the space and satellite business. Segment sales are likely to accelerate in Q4 2021 with “significant margin expansion.” The growth trajectory is expected to further accelerate in 2022.
Therefore, with organic growth and acquisition driven growth, KTOS stock seems attractive. The company is likely to remain free cash flow negative for the year. However, the immediate focus will be on top-line growth and incremental capital expenditure.
Overall, Kratos is operating in some interesting defense segments and the company’s order intake has been healthy. KTOS stock is therefore worth accumulating at current levels.
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Article initially appeared on investorplace.com
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