Introduction (Part 2)

In the first part, I introduced you to the Big 5 American defense stocks. Now I will look at some other, smaller players in this market that you probably don’t know, but which are nevertheless exciting, also from an investor’s point of view.

Transdigm (Ticker: TDG)

A company with an approximate market value of 25 bn. US$ and therefore a medium-sized player, but still small compared to the really big players in the industry such as Boeing or Raytheon.

The first thing that strikes you is the high share price, which ranges between US$ 200 and the all-time high of almost US$ 700. So if you want to buy the usual quantity of 100 units, you have to dig deep into your pockets. In contrast to the Big 5, Transdigm does not pay a dividend.

Transdigm is a group of companies or holding company with dozens of subsidiaries, each specializing in a specific area. The group does not manufacture weapons in the traditional sense, but supplies countless technical components for aircraft, both civil and military. These can include hoses, pumps, measuring instruments, sensors, belts, seats, engines (not engines) and countless other relatively unspectacular parts. As Transdigm is also dependent on the currently struggling commercial aviation sector, the share price has been under pressure for some time. Due to the enormous diversification and various acquisitions, the group is quite confusing, but growth has been considerable. Nevertheless, the debt burden is considerable (long-term debt).

Although the company is diversified, there is hardly any real diversification. Interesting, but there are definitely limits to the upside.

Huntington Ingalls (Ticker: HII)

In contrast to Transdigm, Huntington Ingallos at least offers a dividend of around 2%, but its market value is currently below US$ 10 billion. This makes HII appear to be a niche player, but that is deceptive.

Among other things, this company manufactures aircraft carriers for the US Navy, including the brand new (albeit with many teething problems) Ford class. It also manufactures ships for the US Coast Guard as well as Aegis-class destroyers, which form the backbone of many NATO countries at sea.

The order situation is excellent, the order book (backlog) is full to bursting, for years to come and truly enviable. In addition, Huntington Ingalls (Ingalls is a city, by the way) develops and builds submarines, and this fleet is constantly being renewed, so that there is also considerable potential for further follow-up orders from the US Navy.

The company has a very solid balance sheet, manageable debt and a good gross margin (even if it is falling slightly). The dividend is easily covered and the payout ratio is around 25%. Sales have increased slightly again and again over the years, showing that this is a solid company with good management and a very stable business model. For me, it is the better choice compared to Transdigm and, above all, much more “exciting”.

L3Harris Technologies (Ticker: LHX)

With a market value of around US$ 45 billion, L3Harris is almost a major player. US$, L3Harris is almost a major player. The company manufactures a wide range of electronic warfare systems, simulators, sighting devices (e.g. at night), communication systems, radar and satellite technology, defense systems of all kinds and cyber warfare technologies, as well as many components of the F-35 fighter jet, for example.

With a dividend of just under 2%, the company also offers a certain degree of security as income in addition to the share value. As with HII, the payout ratio is quite well covered (approx. 40%) and the gross margin is well above the industry average. The company was formed by the merger of Harris and L3 and has since been one of the heavyweights in terms of turnover (almost US$ 20 billion/year). The debt burden is relatively low, but the low proportion of cash, which is well behind its competitors, is somewhat disturbing. In addition, the P/E ratio is rather high, making the company rather expensive compared to its competitors.

L3Harris is a company with a strong focus on the military sector and is therefore very dependent on spending by the US Department of Defense. Nevertheless, the portfolio is robust and the management is considered to be successful, practically always exceeding profit expectations. The share price is more stable than that of other companies presented, ranging between US$ 100 and a good US$ 200 (over the last 5 years). Here too, however, the company is currently highly valued, the upside is getting thinner, and large price gains are not to be expected in the near future, assuming the same geopolitical situation without major conflicts.

Kratos Defense (Ticker: KTOS)

The relatively small company Kratos, with a market value of around US$ 2 billion, is a manufacturer of drones. This does not mean large, heavily armed combat drones, but rather small and medium-sized drones that can also be used by smaller troop units for reconnaissance flights, for example. Some of them are extremely light and compact and, depending on the model, can also be carried by one man. However, with the Mako and Valkyrie drones (still in the test stage), which are 6 and almost 10 meters long respectively, Kratos is also entering the domain of armed drones that can carry considerable weapon loads. Also interesting and probably a (worrying) technology of the future are swarms of drones. Another interesting business area is “kits” that can be used to convert manned vehicles into unmanned vehicles. These can then use complex technical systems to operate in enemy territory, sometimes remotely and sometimes autonomously.

In addition, Kratos also offers systems for secure data transmission and against cyber attacks, and Kratos Defense also has various technologies in its portfolio when it comes to satellite technology.

Kratos has a very high P/E ratio, so it is already richly valued, and here too it must be said that the upside is rather thin. No dividend is paid out. The margins are good, and the growth in EBITDA and sales is also considerable. The debt is largely covered by the available cash and is therefore not a problem. Most orders, e.g. from the Air Force, are in the single-digit million range, a different league to the Big 5, but small cattle also make manure, and Kratos Defense is way ahead when it comes to drone technology. However, always bear in mind that with such a low market value, a share issue to generate capital will result in dilution, which could severely “disrupt” the share price.

Conclusion (Part 2)

That was just a small selection of companies. As I said, making money from war and weapons is ethically problematic for some investors. Keep in mind, however, that most of the companies featured are ultimately employers as well, and also provide high-quality and important services in the commercial sector, without which your next flight on vacation probably wouldn’t happen.

Other companies offering in the defense sector (but not limited to) that might pique your interest are:

Leidos (ticker: LDOS, IT and electronics services for the military and others)
Heico (Ticker: HEI, spare parts of all kinds)
Textron (Ticker: TXT, drones & unmanned vehicles, but also Bell helicopters and civilian business jets)
Teledyne (Ticker: TDY, avionics civil & military, electronic warfare and defense, but also medical devices such as scanners etc.)
FLIR Systems (Ticker: FLIR, night vision devices)

You can of course also invest in this sector via exchange traded funds. The following are suitable here:

• Direxion Daily Aerospace & Defense Bull 3X (note: 3x leverage), ticker: DFEN
• SPDR S&P Aerospace & Defense (ticker: XAR)
• iShares U.S. Aerospace & Defense (Ticker: ITA), highest liquidity and market value of these ETFs
• Invesco Aerospace & Defense (Ticker: PPA)
  
  Note: I would also like to point out that the US military has many contracts with pharmaceutical companies, e.g. GlaxoSmithKline (ticker: GSK). This is not only about standard drugs of all kinds for the troops, but also about special vaccines against various warfare agents and biological weapons.