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Can Defense Stocks Maintain Their Momentum in 2018?

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The aerospace and defense sector has been on a rally since last year. This has primarily been due to President Donald Trump’s push to boost defense spending in the United States. Further, a steep reduction in corporate taxes late last year will prove to be instrumental in bolstering growth for the sector in 2018.

Also, Trump’s fiscal 2019 budget plan beefs up spending on defense and military research by as much as $470 billion over the next two years. Under such circumstances, the space is poised to breach boundaries in 2018 as the momentum that the segment picked up in last one year will continue.

Defense Rally to Continue

The space has seen splendid growth over the last one year. This is evident from the rise that the three broader ETFs tracking the sector has experienced in a year. The iShares U.S. Aerospace & Defense ETF ITA, the SPDR S&P Aerospace & Defense ETF XAR and PowerShares Aerospace & Defense PPA have all surged 34.9%, 31.3% and 31.9%, respectively. Notably, all these ETFs have surpassed the S&P 500’s (.INX) performance in the same period where the broader index climbed 17.4%.

Coming to the top players in the industry, we find a similar trend of growth with each of the stocks individually surpassing the S&P 500’s performance in a year’s time. Shares of Raytheon Company , Northrop Grumman Corporation (NOC - Free Report) , Orbital ATK, Inc. , General Dynamics Corporation (GD - Free Report) , Lockheed Martin Corporation (LMT - Free Report) , Rockwell Collins, Inc. and United Technologies Corporation have gained 43.2%, 45%, 43.6%, 19.6%, 34.9%, 46% and 20.4%, respectively. Both the companies possess a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Trump’s Defense Budget Proposal

There’s no denying the fact that Trump’s presidency has come as a boon for the U.S. defense space, which was grappling with the budget sequestration act implemented by the prior government. While the fiscal 2018 (FY18) defense budget reflecting a noble 10% hike from the FY16 level was a major forerunner for this sector’s growth at the beginning of 2017, the FY18 defense policy bill worth $700 billion that extensively surpassed Trump's budget request took stocks to new heights in the second half of the year.

On Feb 12, the Pentagon unveiled its fiscal 2019 budget proposal outlined by the President, in a bid to rebuild the U.S. military into a more agile and lethal force globally. Notably, the budget proposal aims at spending $716 billion on national security.

Of the total, $686.1 billion has been reserved as funding for the Pentagon, reflecting 5% real growth over the initial FY18 President’s budget and 10% real growth over the current Continuing Resolution (CR). The budget includes $617.1 billion as base budget, highlighting a 17.8% increase from the 2018 current CR level, and $69 billion for Overseas Contingency Operations.

Moreover, in the wake of North Korea’s ballistic missile threats, the budget proposal includes an investment plan of $6 billion for varied missile programs. The budget requests for increased investment worth $10.5 billion on facilities, reflecting a 7% rise over the fiscal 2018 base budget request. The funds will be used for fortifying military infrastructure to increase force lethality and minimize the cost of maintaining unneeded capacity.

More Mergers & Acquisitions in Pipeline

In the second half of 2017, we have seen a wave of mergers between big aerospace and defense companies in a bid to fend off competition, restructure business models as well as expand core operations and product lines. United Technologies has agreed to take over Rockwell Collins for $30 billion, while Northrop Grumman is set to buy Orbital ATK for $9.2 billion.

While the deal will make United Technologies one of the world's largest aircraft equipment manufacturers, Northrop Grumman’s product line will benefit from Orbital's rocket motors, missiles and electro-optical countermeasure equipment. Slated to wrap up in 2018, synergies from these mega deals are sure to benefit the sector.

Trump’s zeal to fortify the U.S. military has only strengthened the defense sector’s fortunes. The space rallied throughout last year, breaking boundaries in the second half of 2017 in particular. Most importantly, a reduction in corporate taxes to 21% has opened up more avenues for investments. Such developments have paved way for a plethora of acquisitions in the defense and aerospace segment in 2018.

On Feb 12, the day Trump presented his second annual federal budget proposal, General Dynamics announced plans to purchase CSRA Inc in a bid to venture and gradually expand the government sector business.

Commenting on the deal, General Dynamics’ executive vice president of Information Systems & Technology Daniel Johnson stated that the company has an expanding budget and the analysts within the company believe that the services sector would spring back to pre-2011 conditions when the space was in its prime. This has encouraged the company to invest more on such ventures.

Moreover, major defense contractors can expect a slew of contracts from the Pentagon. On the first day of 2018, Raytheon won a deal worth $333.4 million and Boeing secured a $193.6-million contract. With more such contracts anticipated, we expect major defense stocks to maintain the rally in 2018.

U.S. Leads Global Defense Exports

Emerging nations like Japan and India as well as European countries are raising their defense budgets on account of the widespread geo-political uncertainties. As the United States is the largest supplier of defense equipment, it is without doubt a golden era for Aerospace & Defense stocks.

According to the latest report from Aerospace Industries Association, United States led the global exports in the aerospace and defense segment in 2017. The country accounted for 34% of the total industry export. Further, U.S. Department of Commerce, the defense segment generated an astounding $143 billion from exports alone.

Also, per the report from Aerospace Industries Association, China maintained the top spot as the largest importer of defense products from the U.S., accounting for a total of $16.3 billion worth of goods. Further, France and United Kingdom came in as the second and third, purchasing goods worth $12.9 billion and $10 billion, respectively.

To Conclude

The U.S. defense sector started off 2018 on solid note and is poised to witness stupendous growth in the days to come with a massive defense budget, steep reduction in corporate taxes and a plethora of merger deals and acquisitions lined up for 2018. Its recognition as the largest exporter of defense products in the world is another feather in its cap.

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