The return of president Trump as commander-in-chief could have implications for the US defence budget.
The US is already the largest spender on defence globally, by a wide margin. Despite this, many are forecasting that Trump’s return to the White House could see the US defence priorities shift, and spending increase.
Here are three companies that look well-positioned to benefit if this scenario plays out.
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BAE Systems
As the UK’s largest defence contractor, this might seem an odd choice at first glance.
But the US has become BAE Systems’ most valuable region, accounting for a whopping 45% of sales in the first half of the year. Having such a large exposure to this market has been very beneficial more recently.
BAE's acquisition of US-based Ball Aerospace at the start of the year further strengthened its foothold on the other side of the pond. The acquisition price of £4.4bn was seen as lofty at the time. But space is increasingly being seen as the next frontier in the defence industry and a major route to growth.
Developing your own space programmes is time-consuming, costly and risky. Given Ball already had unique in-space capabilities, we commend the willingness to pounce on the opportunity to bring this ready-to-go business into the fold.
The integration is progressing well and is expected to drive double-digit revenue growth and improve profitability. In time, we expect the acquisition price to be viewed more favourably.
In the existing business, progress has been good. BAE Systems manufactures fighter jets, submarines, ammunition and much more. Recent global events have increased demand for its products, helping the group book around £25bn of orders over the year to early November.
But keep in mind that profitability hinges on an ability to estimate future costs. The long-term nature of many contracts means that the related risks and costs can change over time.
We think BAE’s in good shape to deliver on its growth plans. Despite such a large chunk of its revenue coming from the US, it still trades at a significant discount to its US peers, which we view as unjustified. Operational and supply chain challenges will be difficult to navigate, so some ups and downs can’t be ruled out.
Kratos Defense & Security Solutions
Kratos is a US-based company that focuses on cutting-edge, innovative areas of defence.
It’s particularly known for its unmanned systems, satellite communications and hypersonic capabilities – positioning itself as a disruptor in the sector. With a market value of around $4bn, it’s considerably smaller than the other names on this list.
On one hand, its small size allows it to respond quickly to emerging trends and technological breakthroughs. These can often be overlooked by larger contractors, who tend to be more focused on multi-billion-dollar contracts using older proven tech.
It also makes it an attractive partner for larger companies looking to access its niche expertise, without committing to in-house development. Kratos has already teamed up with industry giants like L3 Harriss and GE Aerospace in the past, proving its credentials.
But its small size also brings risk.
Kratos spends a significant portion of its net revenue on research and development. While this is necessary to be an innovator and grow, it puts pressure on cash flows and margins. If programmes fail to bring in the expected benefits, the group could find itself in trouble.
All but one business unit achieved or substantially exceeded targets in the third quarter. The exception is the commercial satellite business, which continues to be impacted by new entrants and supply-chain disruptions.
A strong outlook for defence spending means revenue is expected to grow at double-digit rates over the next three years. Full-year guidance remains on track, with operating profit expected to remain broadly flat at around $31.6mn this year, before swelling nearly 80% higher next year as drone production ramps up.
Kratos’ valuation is significantly higher than the sector average, reflecting its innovative focus and exciting growth potential. But it leaves little room for error, and any missteps will likely punish the valuation. Potential investors need to focus on the long term and be willing to stomach volatility along the way.
Lockheed Martin
At the other end of the scale is Lockheed Martin. It’s a titan in the defence industry, with a market value of around $128bn.
The US-based group has a diverse portfolio across aeronautics, missiles, maritime systems, space and many more. Given its size and reputation on the global stage, Lockheed looks well-placed to capture any uplift in defence spending at home or across the NATO alliance.
Revenue is expected to grow 5.4% to $71.2bn this year, with the F-35 fighter jet programme typically making up a significant portion of this (26% in 2023). It builds these aircraft in batches, and over time, adds improvements as technology and designs advance.
It’s also responsible for maintaining the aircraft, meaning Lockheed looks set to benefit from these jets for years to come.
But inflation and increased complexity have raised production costs and led to delays. Due to the nature of these contracts, Lockheed’s having to foot a lot of the bill and hope that the programme’s profitability will recover in future periods. With 20 different nations buying these jets, any significant delays could hold back performance.
That’s set to weigh on profits slightly this year. But processes are being streamlined, and operating profits are forecast to grow at mid-single-digit rates over the following two years.
The demand outlook remains strong too. Standing at a record level of more than $165bn, the order backlog is immense and gives great revenue visibility.
The balance sheet is strong enough to withstand some bumps in the road. The ratio of net debt to cash profits (EBITDA) is forecast to be around 1.7 times this year, which we’re comfortable with.
Shareholder returns are also a major focus, with $2.7bn spent on share buybacks so far this year, and a prospective dividend yield of around 2.5% on offer. As always though, no shareholder returns are guaranteed and yields are not a reliable indicator of future income.
Geopolitical tensions have pushed sector valuations higher in recent times, but Lockheed Martin sits broadly in line with peers.
Given its dominant position in a lot of areas and immense revenue visibility, we think this underappreciates Lockheed’s stable growth prospects. But the group’s not immune to cost overruns, and failure to deliver products on time will hurt profits and the valuation.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Investments rise and fall in value so investors could make a loss.
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