For the various defense stocks, these have to be the halcyon days. Thanks to President Donald Trump’s stance on a strong military, the National Defense Authorization Act — also known as the defense budget — has never been bigger. In fact, the defense budget received a nice $22 billion increase for this year. That $738 billion in total spending is a lot of coin for new planes, missiles and other military hardware and software. And with the recent rising tensions in the Middle East and new threats from North Korea, the defense stocks have even more reason to shine.
So, it’s no wonder why stocks like Lockheed Martin (NYSE:LMT) and Northrop Grumman (NYSE:NOC) have been superstars over the last few years. They have provided one heck of a great total return for investors. The question is, do firms like LMT and NOC still have plenty of growth left in the tank?
Going forward, it might make sense to move down the ladder and take a look at some of the smaller defense stocks out there. With such a big budget, even these smaller firms will get a piece of the pie and it doesn’t take much to fill their stomachs in terms of profits. Moreover, the bigger defense stocks are on the hunt for bolt-on merger and acquisition targets. As a result, these smaller wartime stocks could be a great buy in 2020.
With that, here are five smaller defense stocks to consider instead of giants like Lockheed, Northrup or General Dynamics (NYSE:GD).
- Kratos Defense & Security (KTOS)
If there’s one common denominator in all branches of the military, it has to be the removal of the human element from combat. Drones and other autonomous vehicles are now getting the nod for both surveillance and attack missions. Luckily for Kratos Defense & Security Solutions (NASDAQ:KTOS), this is right in its wheelhouse.
KTOS used to be a purveyor of boring communication equipment. But a smart pivot about a decade ago made the firm into one of the best defense contractors out there. These days, Kratos’ product line-up features solutions for a variety of different defense needs. This includes radar, training software, space and cybersecurity products and of course, those unmanned drones.
All of this has provided KTOS with some decent revenue growth. During its last reported quarter, Kratos managed to see 15.5% year-over-year sales growth. Meanwhile, its potential backlog and pipeline of new contracts increased to $7.7 billion. With the U.S. Air Force now taking a shine to its Valkyrie drone, the gains could keep coming. Especially when they cost about $2 million apiece to construct.
Now, KTOS isn’t the cheapest among wartime stocks with a trailing price-to-earnings ratio of 140. However, the potential is great given the use of drones going forward. At the same time, with its $2 billion market capitalization, Kratos is an ideal buyout candidate for a larger firm.
All in all, KTOS stock could be a high-risk, high-reward defense contractor in the years ahead.
- Booz Allen Hamilton (BAH)
Some of the best defense stocks aren’t the ones that actually make missiles or tanks, but those that provide consulting services. And one of the biggest is Booz Allen Hamilton (NYSE:BAH).
Basically, when the U.S. government needs help on a project — whether that be designing a new lightweight gun scope or figuring out better logistics solutions for moving injured troops — they give BAH a call. Booz will then help design, engineer or run a study to help them out. The firm also provides plenty of proprietary cybersecurity software solutions and digital analytics to make mission-critical decisions easier. This focus provides BAH with an advantage over other defense stocks — really huge margins.
Because its only expense is people and software, Booz is able to extract plenty of margins from its contracts. In fact, BAH expects its profit margins to be north of 60% this year. These high margins have helped produce some decent profits at the firm as well as made it a shareholder-friendly stock to own. Buyback activity has continued to rise, while it recently upped its dividend by over 17%.
With an ample backlog and growth among civilian and state-run clients, Booz has plenty of potential to keep the gains going in the new year. While the stock isn’t as “glamorous” as Lockheed, its focus on consulting is wonderful for investors. And in that, BAH is one of the best smaller defense stocks to own.
- TransDigm Group (TDG)
Drones are sexy. Planes are sexy. You know what isn’t sexy? Fuel pumps, water systems and motors. But, without these critical components that F-35 fighter jet isn’t getting off the ground. And this is why TransDigm Group (NYSE:TDG) is a great defense stock for portfolios.
TDG designs and produces various aircraft components. Firms like Lockheed or Boeing (NYSE:BA) call up TransDigm when they need new switches or pumps to incorporate into their designs and production. And because many of these pumps and other basic gear still have to meet military or Federal Aviation Administration specifications, there aren’t many firms out there with scale that can build them. It’s a steady niche that keeps TDG growing.
All of its divisions have seen growth over the last year, with pro forma revenues of defense applications doubling year-over-year. In fact, TransDigm’s total revenues grew by 46% year-over-year in the last reported quarter. That torrid growth should continue as the expanded military budget includes plenty of cash for aerospace build-outs and commercial aircraft demand continues to rise.
And while TDG isn’t a buyout candidate itself, it has smartly used M&A over its history to build and expand its portfolio of complementary products. This should continue as the firm features a high amount of free cash flow.
Given its important niche in the aerospace ecosystem, TDG is a great addition to this list of defense stocks. As spending grows, TransDigm will continue to thrive — no matter who gets the contracts.
- Leidos (LDOS)
“Modernizing defense” is the specialty at Leidos (NYSE:LDOS). After a well-timed merger with Lockheed’s information systems division, the firm is now the largest IT and services business for the defense industry. It’s the tech stock providing a whole host of cloud, cybersecurity and other modernization efforts. This alone has made LDOS a great stock to own as the military seeks many of the same benefits that cloud computing provides regular businesses.
But Leidos isn’t done yet. It’s moving into a whole new realm of providing hardware solutions for the defense industry.
With its planned buyout of privately owned Dynetics for $1.7 billion in cash, LDOS added some new room for growth. Dynetics operates a variety of software and IT products as well as its rapidly growing unmanned aircraft division. This all fits under Leidos’ umbrella. Recently, LDOS ran initial tests for an unmanned Sea Hunter vessel, including on where the ship transited from San Diego to Hawaii without any crew onboard. Leidos has also tested using new sensor technology along with the Sea Hunter. While the program is in its infancy, it certainly has the interest of the U.S. Navy. With Dynetics added in, Leidos now has more avenues for modernization. And in that will come plenty of profits.
With its position in IT affirmed, Leidos’ new moves could make it a powerhouse among defense stocks.
- Flir Systems (FLIR)
Flir Systems (NASDAQ:FLIR) has been around since the late 1970s. But it really got its start in the second Gulf War, when its forward-looking infrared radar (FLIR) was deployed across the battle theater.
From drones using FLIR cameras to soldiers mounting cameras on their helmets to even robots looking for improvised explosive devices, this was the beginning of the next generation of modern tech entering war zones. Since then, FLIR hasn’t looked back. Today, the firm’s products cover a wide variety of applications for military and non-military needs. Heck, HVAC technicians use the firm’s products to find drafts in homes.
And as one of the leaders in the field, revenues continue to be robust. During its latest quarter, Flir managed to pull in $471 million in revenues. That was an 8% year-over-year jump. More importantly, the firms backlog managed to jump by nearly 17%. Backlog gains are critical for defense stocks as it represents cash in the bank down the road. With new products and several new partnerships, Flir Systems should continue to see its star shine as the defense budget is handed out.
For investors, this is great news. FLIR stock has already been a provider of steady returns, and with its strong cash flows, the firm has become a decent dividend stock as well. Thanks to its steady payout, FLIR stock now yields 1.3%. While not a life-changing yield, it’s still impressive given its niche and that most smaller defense stocks pay nothing at all.
In the end, the company operates as a wonderful producer of a specialized product. And it’s one that should find a home in your wartime stocks portfolio.
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