Defense contractors

[dealraker]

Because I read all of Spek's comments and think these are often quite astute I'd added significantly to my defense stocks recently, LHX-RTX-GE particularly.  While I've made mistakes with this sort of what seemed logical general thinking before most of the time it works very well.  I think the defense stocks are a solid value for those planning to hang on for a while.

 

I've owned them all for decades, it just seemed a really good time recently to add.  But distracted I was as usual until Spek brought me back in line.  I recently got handed a few trusts to manage for a while and they got a solid dose of defense stocks.  

 

We will see.  Wars don't always add up to what we think as to defense sales and profits. 

Edited October 9, 2023 by dealraker

[Spekulatius]

@dealraker Xes, looking the big strategic picture as well as the current valuations, I like LHX and RTX in particular. Both have issues to work through that I think are going to be either gone or at least much smaller 2 years from now. The business itself will be around ages from now.

I posted this in another thread , but I am reposting it here as I lifted an old annual report from Lockheed Aircraft corporation  from 1958 (from Mergent archive lifted through my library access)  reading this old annual reports. Interesting how they talk about the newly developed C-130 transporter and that airplane is still around today 65 years later. Other stuff like that circular space station never got off the ground.

Lockheed 1958ß.pdf

Edited October 9, 2023 by Spekulatius

[no_free_lunch]

Is anybody else a little upset that an entire thread just disappeared....

 

I am fine with no politics but then why are we discussing Ukraine...

 

 

Edited October 9, 2023 by no_free_lunch

[valueseek]

57 minutes ago, Spekulatius said:

@dealraker Xes, looking the big strategic picture as well as the current valuations, I like LHX and RTX in particular. Both have issues to work through that I think are going to be either gone or at least much smaller 2 years from now. The business itself will be around ages from now.

I posted this in another thread , but I am reposting it here as I lifted an old annual report from Lockheed Aircraft corporation  from 1958 (from Mergent archive lifted through my library access)  reading this old annual reports. Interesting how they talk about the newly developed C-130 transporter and that airplane is still around today 65 years later. Other stuff like that circular space station never got off the ground.

Lockheed 1958ß.pdf 29.84 MB · 2 downloads

I recently did the exercise with RTX. Went to the last 20 years, when the stock traded at lowest valuation vs. say past 3-5 year history, the overall stock return to date (obv. impacted by the curr. forward PE multiple as well), was 9-10% per year or so. So not bad but not what I would have guessed. Last 20 years RTX EPS growth has been 7%.

 

So I agree, RTX looks good here for medium long term but harder to get north of 10%+ for longer holds. Just my guess. The UTX deal may have messed up some of the numbers but I tried accounting for it.

 

LHX on the other hand had grown much more than RTX over the years through various acquisitions. Going forward, EPS growth may be higher here. Anyways, looking at 10-20 year PE multiple charts, defense stocks go through bouts of lower and higher PE's. 2018 their PE's went to astronomical levels being compared to cons. staples. - that is how the 23+ times forward PE multiples were being justified. PE multiple collapsed to 11-12 times in 2020 as defesne spending outlook shrunk with Democrats win. 2022 - the Russian Ukraine increased the PE to 18+ times. Since then the PE's have been coming down. The defense businesses are different than core manufacturing businesses as in the margins dont keep on expanding much but the defense businesses generally are quite capital efficient - dont use a ton of capex and govt. subsidizes some of the R&D.

 

Anyways, buying them below 15 times PE has worked out well generally with 8-12% annual returns depending in the time period.

[mcliu]

1 hour ago, no_free_lunch said:

Is anybody else a little upset that an entire thread just disappeared....

 

I am fine with no politics but then why are we discussing Ukraine...

 

 

+1 Yes.

Why was it deleted? 

[Xerxes]

2 hours ago, valueseek said:

I recently did the exercise with RTX. Went to the last 20 years, when the stock traded at lowest valuation vs. say past 3-5 year history, the overall stock return to date (obv. impacted by the curr. forward PE multiple as well), was 9-10% per year or so. So not bad but not what I would have guessed. Last 20 years RTX EPS growth has been 7%.

 

So I agree, RTX looks good here for medium long term but harder to get north of 10%+ for longer holds. Just my guess. The UTX deal may have messed up some of the numbers but I tried accounting for it.

 

LHX on the other hand had grown much more than RTX over the years through various acquisitions. Going forward, EPS growth may be higher here. Anyways, looking at 10-20 year PE multiple charts, defense stocks go through bouts of lower and higher PE's. 2018 their PE's went to astronomical levels being compared to cons. staples. - that is how the 23+ times forward PE multiples were being justified. PE multiple collapsed to 11-12 times in 2020 as defesne spending outlook shrunk with Democrats win. 2022 - the Russian Ukraine increased the PE to 18+ times. Since then the PE's have been coming down. The defense businesses are different than core manufacturing businesses as in the margins dont keep on expanding much but the defense businesses generally are quite capital efficient - dont use a ton of capex and govt. subsidizes some of the R&D.

 

Anyways, buying them below 15 times PE has worked out well generally with 8-12% annual returns depending in the time period.

neither RTX nor LHX has become the cannibals of their own shares as much as Lockheed, Northrop and General Dynamics have become in the last 10 years. 
 

RTX and LHX have been going through M&A which what the other three went through largely from 1995 to the 2010s. Once their portfolio of the trio was set, they became buyback machines. I expect the same from RTX and LHX. 

[valueseek]

@xerxes. You are right. Last 20 years, NOC, LMT bought back some 4%, 3% of sh. outst. annually. While RTX increased sh. count by 2%. That explains most of the delta in the annual stock performance bw. NOC/LMT and RTX. Other difference is the margin expansion at NOC has been at a faster rate in the last decade from a lower starting base of margins. Vs. RTX margins are reasonably at the higher end. Anyways, at these levels with a longer time horizon, HSD-LDD kind of total annual returns seem very reasonable - a lot more buybacks than in the past would need to move them higher as sales and margins are not going to be the drivers here.

[Stuart D]

13 hours ago, mcliu said:

+1 Yes.

Why was it deleted? 

Yeah, I kept looking but couldn’t find it, so I guess it’s deleted.

[no_free_lunch]

4 hours ago, Stuart D said:

Yeah, I kept looking but couldn’t find it, so I guess it’s deleted.

 

It bothers me. 

 

I don't think I can, with good conscience, be part of some unknown censor protocol.  It would have been fine if we just weren't allowed to talk politics at all but to have people casually discuss the slaughter of Ukrainians and Russians and then randomly draw the line at Israel/Palestine.. It's too much for me.  Admin are well within their rights to set limits but I am within my rights not to take part.  I am sure no one cares but that's my go forward protest.  I will lurk on the sidelines.

[jouni1]

Any educated opinions on European companies such as Kongsberg, Saab, and Safran etc? Saab excluding the fighter jet business seems like they could do well in the current environment.

[Dinar]

24 minutes ago, jouni1 said:

Any educated opinions on European companies such as Kongsberg, Saab, and Safran etc? Saab excluding the fighter jet business seems like they could do well in the current environment.

I have been long Safran for a while, but Safran's bread and butter are engines for commercial airplanes, it is not the best play in my opinion on higher defense spending.  

[JAK]

On the back of the Acquired podcast on LMT, I recently started reading Skunk Works by Ben Rich. Oldie, but very interesting read. Noting here in case anyone’s interested.

[schin]

19 hours ago, no_free_lunch said:

 

It bothers me. 

 

I don't think I can, with good conscience, be part of some unknown censor protocol.  It would have been fine if we just weren't allowed to talk politics at all but to have people casually discuss the slaughter of Ukrainians and Russians and then randomly draw the line at Israel/Palestine.. It's too much for me.  Admin are well within their rights to set limits but I am within my rights not to take part.  I am sure no one cares but that's my go forward protest.  I will lurk on the sidelines.

 

I do not know for sure what the Ukraine thread got delete, but whoever started the thread has the ability to delete it...  I was asked to do for a duplicate Mohawk thread and it was pretty easy.  I initiated it and had the power to erase.

 

Parsad also as the admin... but, the creator of the thread probably deleted it.

[Xerxes]

3 hours ago, JAK said:

On the back of the Acquired podcast on LMT, I recently started reading Skunk Works by Ben Rich. Oldie, but very interesting read. Noting here in case anyone’s interested.

Agreed. It is wonderful book. I read it about 15 years ago. Loved the part where Blackbird pilots would go flying all the way to North Pole and when gone back home for supper, they couldn’t answer their wives on “how was their day”. I am guessing pilots didn’t stay on site. 
 

Also I would recommend this book. About the father of U.S. nuclear submarine fleet. Covers “Electric Boat”, an GD subsidiary, and a less glamorous era for General Dynamics. 

Kelly Johnson and Rickover were the Elon Musks of that era 

 

 

 

 

Edited October 11, 2023 by Xerxes

[Spekulatius]

Skunk works is good but if you prefer the audio format (which I do nowadays) then the Acquired Podcast episode is very very good.

 

I personally also will go through older annual reports for some business, I posted the Lockheed Corp annual report from 1958 and they are just such a wonderful read. I whish they would write annual reports like this nowadays.

[JAK]

46 minutes ago, Spekulatius said:

Skunk works is good but if you prefer the audio format (which I do nowadays) then the Acquired Podcast episode is very very good.

Yeah, I’m big on audio also .. found Skunk Works on Audible.fr !  Agree on Acquired, well worth a listen.

[UK]

https://www.investing.com/news/economy/us-must-be-ready-for-simultaneous-wars-with-china-russia-report-says-3197258

[Spekulatius]

8 hours ago, UK said:

https://www.investing.com/news/economy/us-must-be-ready-for-simultaneous-wars-with-china-russia-report-says-3197258

I think the US and the western world needs to build some surge capacity to increase the military industrial complex (ha) output when needed. I think one thing we learned is that conflicts could be more protracted then assumed resulting in much higher consumption rates of material and consumables.

 

Right now, the defense contractors are not capable of providing capacity, beyond what is planned in the budgets and even that isn’t a sure thing with all the political shutdowns. So, there is no surge capacity whatsoever. COVID-19 has clearly showed this with secondary impacts on external supply chains, even though the defense contractors and their suppliers were never shut down (deemed essential work). Yet, the whole supply chain snarled  and there wasn’t even a war going on (until 2022 that is).

Talent also is leaving due to retirements and difficulty replacing the jobs because the younger people are not exactly keen on getting this sector for good reasons, imo (economic mostly ). It is not the 60‘s any more and what you read in the book about Lockheed/  skunkwork book.

 

Some political decisions will need to be made for the longer term.

[UK]

4 minutes ago, Spekulatius said:

I think the US and the western world needs to build some surge capacity to increase the military industrial complex (ha) output when needed. I think one thing we learned is that conflicts could be more protracted then assumed resulting in much higher consumption rates of material and consumables.

 

Right now, the defense contractors are not capable of providing capacity, beyond what is planned in the budgets and even that isn’t a sure thing with all the political shutdowns. So, there is no surge capacity whatsoever. COVID-19 has clearly showed this with secondary impacts on external supply chains, even though the defense contractors and their suppliers were never shut down (deemed essential work). Yet, the whole supply chain snarled  and there wasn’t even a war going on (until 2022 that is).

Talent also is leaving due to retirements and difficulty replacing the jobs because the younger people are not exactly keen on getting this sector for good reasons, imo (economic mostly ). It is not the 60‘s any more and what you read in the book about Lockheed/  skunkwork book.

 

Some political decisions will need to be made for the longer term.

 

It seems this is the direction everything is going. The question though, as Buffett used to say, how well this will translate into shareholder returns with defense companies? 

[Xerxes]

 

Once you gave the “the last supper” speech of ‘less business going forward so consolidate’, right after the fall of Soviet Union. That base dissipated. That industrial base will take decades to be rebuilt.

 

One of the reason why Bank of America and other analysts are harping on Boeing, is due to the fact that it may lose its engineering force through attrition. Sure from a short-term shareholder point of view, what Boeing is doing is great. Get that juice into FCF (for returns) and less Capex and capital investment. See what happened to McDonnell Douglas. 
 

Given the level of concentration in the defence industry, we are at the level that major programs are not just awarded based on cost, performance, specs etc but also knowing that if X wins and Y loses, the loser will just move away and will not be there to bid and keep competition for the next round. 

[Castanza]

5 hours ago, Spekulatius said:

think the US and the western world needs to build some surge capacity to increase the military industrial complex (ha) output when needed.

That becomes more difficult with how advanced equipment becomes. LMTs first jet airplane was built with 6 full stack engineers in 143 days (concept -> production). The stuff coming out today is incredibly complex. Where do you get the capacity for scale? I would think you need very complex facilities. Also with how co reacted out small parts are, I would think this “extra capacity” would be more difficult out down chain as you move towards the smaller suppliers. Likely would be harder for them to justify this “just in case” capacity with their much smaller budgets. 

[UK]

https://www.wsj.com/finance/what-defense-stocks-say-about-a-more-violent-world-926b24f5?mod=hp_minor_pos20

 

[fareastwarriors]

1 hour ago, UK said:

https://www.wsj.com/finance/what-defense-stocks-say-about-a-more-violent-world-926b24f5?mod=hp_minor_pos20

 

 

Buy at 10-15 p/e and sell at 20+ p/e. got it.

[Spekulatius]

1 hour ago, fareastwarriors said:

 

Buy at 10-15 p/e and sell at 20+ p/e. got it.

this works not just for defense stocks, I recon.

[UK]

https://www.bloomberg.com/news/articles/2023-10-20/white-house-requests-116-billion-for-israel-ukraine-border?srnd=premium-europe&leadSource=uverify wall

 

In the Ukraine portion of the request, the White House is asking for additional weapons systems, economic and civilian security assistance, nuclear crisis management, and support for Ukrainian refugees in the United States. Because the weapons and ammunitions sent abroad are largely taken from existing US stockpiles that are then replaced by new equipment made in America, the White House says the president’s request would invest over $50 billion in the US defense industrial base.