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Defense Stocks Winning Sequester Battle


These truly "defensive" stocks continue to earn big money despite the government's nominal austerity.


The sequester is a failure, even as a token of congressional resolve to endure real austerity.

As soon as the predictable, preventable cuts to the Federal Aviation Administration began snarling air traffic around the country, the Senate rushed through a midnight bill freeing the money. And the House promptly rubber-stamped it, as demanded by airlines and frequent flyers.

The FAA was allowed to juggle internal funds to end air traffic controller furloughs, though other federal agencies will continue to be denied this luxury, steadily eroding vital infrastructure, military preparedness, and regulatory functions, all at the public's ultimate expense.

But you know who are not sweating the sequester, even a little? Investors in defense contractors, which are still flying high while thousands of Pentagon employees enjoy their unpaid days off.

Lockheed Martin (NYSE:LMT) shares are at a four-year high after the defense giant posted a 15% increase in earnings per share, beating the consensus estimate by 29 cents even as revenue slipped 2%.

Most impressively, it spent $830 million during the quarter on dividends and buybacks, a pace that if sustained for the entire year would amount to a 10% return on Lockheed's market cap. The dividend yield of 4.7% is no doubt a big part of the stock's appeal.

The sequester's modest effect on the government's procurement of the troubled new F-35 stealth fighter will only serve to increase the taxpayers' cost per jet, while doing little to stem the long-term acquisition tab - estimated at nearly $400 billion (not counting $1 trillion in lifetime operating expenses).

But the F-35 isn't just an incredibly expensive boondoggle. It's also a jobs program, an exports program, and a foreign policy tool. Israel will help make the jet's wings, and has signed on as a key early buyer. Japan, Australia, South Korea, and Singapore are in line too, alongside European allies.

In an insecure world, a guaranteed profit on a guaranteed revenue slice that big is as close to a sinecure as you can get. Many investors certainly seem to prefer it to broader exposure to the slowing global economy. It's one reason Lockheed Martin's shares have been advancing alongside those of cola marketers and diaper slingers.

Other weapons suppliers are also having little trouble squeezing extra profit from every federal dollar, for the moment. Raytheon (NYSE:RTN) posted a 9% increase in operating earnings even as sales slipped 1%, and boosted the annual profit forecast (while reeling in revenue guidance a bit).

Northrop Grumman (NYSE:NOC) saw sales and profits slip as well, yet easily outdistanced estimates on both counts. The CEO said the sequester won't cause any program cuts this year, but might in 2014, if political deadlock persists. But he also noted that President Obama's proposed budget "supported many of our largest programs."

Northrop is another F-35 beneficiary, registering a 4% aerospace revenue increase thanks to the program. Over the last year, it has bought back 7% of its shares, in addition to paying a 3% dividend.

Defense stocks could get a lift later this year if the long-sought budget deal is finally reached, if only because continuing the stalemate won't serve anyone's political needs much longer. And in the longer run, Dwight Eisenhower has certainly been proven right about the military industrial complex's staying power.

Sequesters will come and sequesters will go, but $170 million fighter jets and billion-dollar buybacks are here to stay. Taxpayers are on the wrong end of that money engine. But shareholders seem to like their spot just fine.

Editor's Note: This article was written by Igor Greenwald of Investing Daily.

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