Defense Sector: The Sequester Fears Are Unfounded

by Jason Jenkins

As investors realized Congress would fail to avoid the foolish threat of "sequestration," all eyes turned toward the defense sector. After all, there's no better synonym for perverse government spending than "military contractor."

Most investors are convinced the defense sector will lag as Uncle Sam cuts his spending. But their worries have not yet proven true.

At the end of April, the big five defense contractors reported earnings that beat Wall Street expectations. These earnings reports were the initial pieces of information released to the public after the across-the-board cuts were put into action.

So far so good.

Even before Congress threatened strong Department of Defense cuts, U.S. defense contractors prepared for a dip in Pentagon spending. With an anti-war president in power, they could read the writing on the wall.

In anticipation, major contractors downsized and consolidated operations. They cut the less-profitable parts of their businesses.

But the other move they made, and this is huge, was to seek out new markets. Companies looked outside American borders for alternative markets.

During the recent earnings season, the brass at the top defense contractors preached the benefits of international markets on their first quarter conference calls. All of them revealed that domestic cuts are and will be balanced out by expansion outside the United States.

And this wasn't just the executives blowing smoke.

Always a War Somewhere

The world is a dangerous place. The United States can't police every threat.

Countries across the globe are desperate to defend themselves from an array of threats. That means the demand for American military technology is expected to stay strong.

For example, many countries in the Middle East are terrified of Iran and the possibility it could obtain nuclear weapons. With strong oil prices lining their coffers, many Gulf countries have turned to American contractors for military aerospace products.

It's a similar story in China. As the country's economy expands, its government has greatly increased defense spending. Many American military companies are finding strong demand in China.

The Winners

There are four major players poised for future success. They are Lockheed Martin (NYSE: LMT), Boeing (NYSE: BA), General Dynamics (NYSE: GD) and Raytheon (NYSE: RTN).

Two of them are excellent examples of companies doing big business as global defense spending surges.

For example, Australia just ordered 100 of Lockheed's popular F35 fighter jets. Lockheed CEO Marilyn Hewson said in conference call that the global sales of the fighter - along with other programs - will aid in growth.

"We are on a path to grow international sales from approximately 17% of total revenues last year," she said, "to at least 20% in the next few years."

Earlier this year, the company had meetings with Italy and a host of Middle Eastern countries such as as Israel and Saudi Arabia. The meetings focused on an array of security issues like fighter jets, missile defense and cybersecurity.

These are all areas where Lockheed Martin will increase its international sales.

In recent conference calls, Raytheon CEO William Swanson said, "International continues to be a key differentiator for the company. In Q1, our international business represented 26% of our total sales. We have a very broad offering and a multitude of capabilities that serve our international partners well. We see a lot of strength - and we see it growing meaningfully."

All told, Raytheon's overseas orders should increase 20% for 2013.

The bottom line is Washington's budget cuts are real, but they are nowhere near as deadly as many naysayers want us to believe. The biggest and smartest defense companies saw the cuts coming and they reacted appropriately.

The filled the domestic void with an array overseas opportunities.

Despite the dire rhetoric, the top four players - especially Lockheed Martin and Raytheon - are well-positioned for the future.

Good investing,


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