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Investing in the War on ISIS

Written By Briton Ryle

Posted October 31, 2014

The U.S. government is ramping up its war machine as strikes against the Islamic extremist terror group Islamic State continue. And that means writing more checks to defense contractors.

The three-month long Operation Inherent Resolve against Islamic State terror forces mostly in northern and central Iraq and partly in Syria has already cost the U.S. over $424 billion in just its first 10 weeks as reported by the Wall Street Journal. That’s an average of just over $6 million each day.

As a result, military stockpiles of missiles and weapons need to be replenished, driving up total military spending in Q3 to $149 billion, up from $137.9 billion in Q2, which in turn was up from $136.7 billion in Q1. Defense spending has been increasing at a faster rate all year.

But the spending is being allocated a little differently this year, given the nature of America’s involvement. Since the government’s effort against ISIL is focussed entirely on air strikes, a larger percentage of 2014’s expenditures have been devoted to missiles, ammunition and communications.

This means that the contractors benefitting from today’s military spending will include more than just the same old line-up of Boeing, Lockheed Martin, General Dynamics, Raytheon and Northrop Grumman, but will encompass a number of smaller players you might not have heard of as often. This should peek investors’ curiosity, as the little stocks can surge upward with a pretty powerful bang once their fuses are lit.

So who are these little players of the military world that have suddenly been served a bigger piece of the defense budget pie? Let’s take a quick look at four of them.

Little Contractors are Elbowing In

Plotting our top five most well-known defense contractors with our four smaller lesser-known ones on a 5-year graph gives us pretty much what we would expect:

• The top three performers are the giants – Northrop Grumman (NYSE: NOC), Lockheed Martin (NYSE: LMT) and Boeing (NYSE: BA) – their stocks soaring miles above the rest.

• The bottom three performers are the lesser-known little guys – CACI International (NYSE: CACI), L-3 Communications (NYSE: LLL) and Alliant Techsystems (NYSE: ATK) – their stocks underperforming the rest including the broader market S&P.

war on isis investments chart one


Yet looking at the same companies over the past two years produces quite a different line-up:

• The top three performers now include ATK which used to be one of the bottom three.

• All of the smaller contractors have closed-in on giants Boeing and Raytheon which have stalled.

• All contractors including the small are outperforming the S&P by at least 50% more (where the S&P has gained 40% over the past two years, the least of the contractors has risen 60%).

war on isis spending chart two


As can be noted at the far right of the graph, nearly all contractors on our list enjoyed a large spurt over the past few weeks as U.S. strikes against ISIL have intensified. But the bigger gains have been enjoyed by the little guys, a trend which is likely to continue according to analyst projections.

Four Smaller Defense Contractors to Keep an Eye On

We already know our five big-boys: Boeing ($88 billion market cap – aviation), Lockheed Martin ($59B – aviation), General Dynamics ($45B – tanks), Raytheon ($31B – missiles), Northrop Grumman ($27B – aviation).

But you likely haven’t heard much about the fellowship of the four little hobbits who are currently being entrusted with a very special mission in the middle east:

• Textron Inc. (NYSE: TXT) ($11 billion market cap): owns Bell Helicopters, Cessna Aircraft Company, and Textron Systems; is a leader in drone technology; maker of the OH-58D Kiowa Warrior helicopter used for armed reconnaissance and light air combat missions.

• L-3 Communications Holdings (NYSE: LLL) ($10 billion market cap): owns C3ISR (Command, Control, Communications, Intelligence, Surveillance and Reconnaissance) system used by all branches of the U.S. military; owns the small manned airborne intelligence-gathering platform (SPYDR) used to capture real-time mission-critical intelligence.

• Alliant Techsystems (NYSE: ATK) ($3.5 billion market cap): the largest provider of ammunition to the U.S. military and its allies, producing up to 1.4 billion rounds of small-caliber ammunition per year; selected by the U.S. Navy to develop the Advanced Anti-Radiation Guided Missile (AARGM).

• CACI International Inc. (NYSE: CACI) ($1.9 billion market cap): supplying the U.S. Army with battlefield information through the TROJAN satellite communication systems, a global network of shared mission-critical intelligence.

Of course, there are hundreds more small defence contractors that will also benefit from the U.S.’s increasing involvement against ISIL. But these four are certainly among those whose equipment and services are highly matched to the current task at hand, with a focus on surveillance and ranged weaponry.

Analyst Growth Forecasts

Here’s the fun part every investor is most interested in: just which companies have the better anticipated future growth potential? Once again the same pattern emerges, with the little guys elbowing past the giants.

These are their 2015 and 5-year earnings growth projections ranked from highest to lowest for 2015:

• Textron: +21.20% (2015) and +20.65% (5-year average)

• L-3: +15.90% and +3.55%

• Alliant: +10.20% and +13.50%

• General Dynamics: +7.5% and +8.51%

• Boeing: +3.10% and +10.70%

• Lockheed: +3.00% and +9.66%

• CACI: +2.80% and +10.00%

• Raytheon: +1.60% and +10.29%

• Northrop: -1.6% and +6.65%

The revenge of the little guys is nearly complete, with three of the four smallest contractors covered here appearing in the top three spots on the list. Yet the last of the four – CACI – does beat three of the giants in 5-year average growth.

Warfare in the 21st century has taken on a whole new profile, with reconnaissance and long-distance strike capabilities now being nearly every military’s top priorities. As these involve highly specialized technologies and equipment, it is virtually impossible for one or two or three mega corporations to be the broad-spectrum contractors they once used to be half a century ago.

In today’s military infrastructure there is plenty of room for vast numbers of small, highly specialized companies all feeding together on the modern world’s new wartime needs. And that means plenty of contractors for investors to choose from, with the biggest bang for your investment buck being deployed by the little guys.

Joseph Cafariello