) and a hold on Boeing (BA
) and Alliant Techsystems (ATK
). Although at S&P we expect NASA to suspend the shuttle program indefinitely, we don't believe that its actions will materially affect the already mediocre long-term prospects of Lockheed and Boeing (see BW Online, 11/8/02, "Guns Won't Butter Much Bread").
NASA and shuttle-related sales account for only 4% and 3% of total sales for Boeing and Lockheed, respectively. Boeing manufactures the shuttle's main engines, originally built by Rockwell International (that business is now part of Boeing), and Lockheed produces the external fuel tank. United Space Alliance, a joint venture between the two companies, manages and maintains the shuttle program.
Since Alliant generates 17% of revenues from shuttle sales, it will be more adversely affected. Alliant, one of the world's largest makers of precision ammunition, produces the rocket motors that propel the shuttle into space. Though Alliant is well positioned to capitalize on growing global military demand for precision weapons and defense electronics -- the only relatively fast-growing segments of an otherwise sluggish global defense industry -- we at S&P have a hold ranking on the stock mainly because of its rich valuation.
WANING INTEREST. Based on our fiscal 2003 (ending Mar. 31) earnings-per-share estimate of $3, Alliant stock is trading at a p-e of 16, a significant premium to its projected 7% average annual EPS growth potential. Even with Feb. 3's nearly 12% drop, to about $48, Alliant is now only nearing our fair-market-value assessment of $40 to $55.
Defense stocks have pulled back in recent weeks, primarily because investor interest in big contractors Lockheed Martin, Northrop Grumman (NOC
), and Raytheon (RTN
) has waned. Year-to-date through Jan. 31, the S&P Aerospace & Defense Index underperformed the S&P Super 1500 Index, falling 5%, while the broader market index fell 2.3% (see BW Online, 1/7/03, "Playing Defense with Defense Stocks").
Last year, big contractors' stocks performed better than many other areas of the market, boosted by expectations of big hikes in the U.S. defense budget. The industry index fell by only 7.2% in 2002, compared to a 22.5% decline in the broader market.
LARGE PREMIUMS. Despite the specter of military action in the Middle East, S&P still believes that the overall U.S. military procurement budget will grow at moderate long-term rates. As America's main adversaries are utilizing small, scattered terrorist cells as the primary means of warfare, influential figures within the Pentagon, including Defense Secretary Donald Rumsfeld, question the need to maintain or increase huge arsenals of traditional weapons systems such as fighter planes, tanks, and ships. Consequently, we still forecast that long-term military procurement spending will grow at average annual rates of 2% to 4%.
Even after the recent weakness in stock prices, our valuation models indicate that most defense contractors -- except for Boeing -- are trading at high multiples to their sustainable cash-earnings growth. Consequently, S&P still thinks most defense-industry stocks are selling at large premiums to intrinsic value. Analyst Friedman follows aerospace and defense stocks for Standard & Poor's