Defense Stocks In Focus Following Hagel's Exit Amid Crisis

Defense Secretary Chuck Hagel stepped down on Monday amid continuing tensions in the Middle East. The U.S. has gotten more and more involved in its attempts to root out terror in this war ravaged region. The resignation of Hagel marked the first major change in Obama's Cabinet since his Democrats were beaten hollow in midterm elections three weeks ago.

A Shift in Obama's Defense Policy?

Hagel − a Republican with military experience − had assumed office in early 2013 to end expensive ground wars in Iraq and Afghanistan, and manage a massive budget retrenchment at the Pentagon.

The exit of Chuck Hagel was triggered off by national security challenges and a revision of the Afghanistan exit plan which pressed the President to shake up its security staff. Hagel's antiwar contour seemed to be less valuable when the government is increasingly inclined on a war footing.

With the President accepting the resignation of the Defense Secretary there is little doubt that the administration may be willing to alter its foreign and national security policy mired as it is in crisis and controversy. There was also a buzz about Chuck Hagel running into a dispute with Susan E. Rice, the national security adviser, over the Syria policy.

Some critics suggest that a tarnishing of Obama's popularity and the historic Republican win in the recent midterm elections may be the reason for this major realignment. The administration's slow response to the rising threat from the Islamic State (“IS”), its nuclear negotiations with Iran, hesitant reaction to Russian aggression in Ukraine as well as a threatened Ebola epidemic in Africa raised some uneasy questions. Obama is also under pressure to resolve a still unfinished war in Afghanistan. Chuck Hagel thus became an easy target for a host of complex problems.

How will the Defense Majors Gain from this?

Hagel's resignation along with the Republican win may turn out to be a catalyst for the defense sector. The Republicans have always supported higher defense spending. This would bring gains for industrial behemoths like The Boeing Co. BA, General Dynamics Corp. GD and Lockheed Martin Corp. LMT.

Ironically, the Pentagon remains committed to the Defense Innovation Initiative that was announced by Hagel at a defense forum in California on Nov 15, 2014. This initiative entails efforts to identify and develop new weapons to sustain U.S. military dominance keeping an eye on Russia and China.

The Obama administration has already requested Congress for a $5.6 billion budget amendment to conduct military onslaughts against the IS. Of the total fund, $5 billion is planned for the Defense Department. That's in addition to Pentagon's fiscal 2015 defense budget of about $554 billion, including a base budget of $496 billion and a war budget of about $59 billion. The Congress hasn't as yet approved the spending plan for the fiscal year beginning Oct 1.

These moves are already speaking of the shifts that the Obama administration might be considering. Defense contractors have gained steadily ever since the ISIS conflict began. These stocks have not only featured prominently in the news but also exceeded the performance of the broader market by a wide margin. Some have touched all-time highs in recent times.

Needless to say the defense industry – at the forefront of the country's protection and security – gains during times of war and conflict. This is borne out by the performance of defense stocks during the first Gulf War as well as the conflict with the Taliban in Afghanistan following the 9/11 attacks.

Stock Picks in Times of Global Crisis

The possible source of new funds and continuing skirmishes against adversaries in Iraq and Syria are expected to charge up these defense stocks in the quarters ahead.

Lockheed Martin Corp. is the leading defense contractor of the nation. Hellfire missiles from this Bethesda, MD-based company are in demand now as the U.S. restocks its arsenal. This Zacks Rank #3 (Buy) stock reported a positive 1.47% earnings surprise in the last quarter. The company has delivered positive earnings surprises in the trailing four quarters with an average beat of 13.24%. Its shares gained 26.9% so far this year.

The expected earnings growth of Lockheed Martin is 8.5%. The forward price-to-earnings ratio (P/E) for the current financial year is 16.87. Return on equity (ROE) is at an impressive 76.5% as compared to the peer group average of 18.5%.

Raytheon Co.'s RTN Tomahawk cruise missile is said to be President Barack Obama's weapon of choice. Tomahawk has become an important weapon in the U.S. defense arsenal for its precise capability to take out high value target from a very long distance. These missiles have a range of 1,000 nautical miles (1,150 statute miles) and can be launched both from surface and submarines. The latest version, Block IV, has a satellite link that enables it to hover over the battlefield as it awaits target instructions.

This Zacks Ranked #3 stock has a forward P/E of 15.5, and a discount of 19.6% from the peer group average of 19.29. Long-term earnings per share growth are expected to be 8.3%. ROE is 17.6% versus 4.8% of the peer group. Its shares advanced 17.3% year-to-date.

General Dynamics Corp. engages in mission-critical information systems and technologies; land and expeditionary combat vehicles, armaments and munitions; shipbuilding and marine systems; and business aviation. The company operates through four segments: Information Systems & Technology (IS&T), Combat Systems, Marine Systems and Aerospace.

The company currently holds a Zacks Rank #2 (Buy) and has expected earnings growth of 7.79%. It has a P/E of 18.7x. ROE stands at 18.8%, a little above the peer group average of 18.5%. Since the start of 2014, there have been a number of share price gainers among the pure-play defense majors, with General Dynamics leading the pack with a 51.3% gain.

Boeing is a premier jet aircraft manufacturer and one of the largest defense contractors in the U.S. The company currently holds a Zacks Rank #2 (Buy) and has expected earnings growth of 10.72%. It has a P/E of 16.16x. ROE stands at 41.8% versus 18.5% average for the peer group.