Armed conflict does not necessarily benefit defence contractors fundamentally, especially if the conflict is prolonged and expensive, says Owens, maintaining his fair value estimates on names like General Dynamics, Lockheed Martin, Northrop Grumman and Bombardier.
“We have not altered our valuations of defence contractors in light of this news, and we believe long-term development and resupply of missile defence technology are already baked sufficiently into our forecasts,” he adds.
In the short term, munition resupply orders can add to sales, though these are “not usually big relative to total revenue”, notes the analyst.
However, a “drawn-out” conflict could sap military budgets and divert funds to operations and logistics, and away from research, development and procurement. The latter operations are where contractors make the “bulk of their money”, he adds.
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Still, Owens acknowledges that some bulls highlight defence names as a “tactical rotation” to a sector “generally insulated from macro shocks”, such as the oil price spike that also accompanied the Israel-Iran news.
Owens also cites “two narratives” to justify snapping up defence contractors, though he discredits them as “neither holds much fundamental water”.
“First, the idea that combat fuels more purchases of weapons made by a given firm and makes that company’s stock worth more ignores how long in advance militaries procure weapons, subject to strategic and political constraints,” he writes.
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“Second, that increased geopolitical instability broadly stimulates defence budgets, and thus defence contractor revenue is more logical. Still, we don’t see incremental upside to global defence spending from the supercycle we already forecast,” adds Owens.
In a June 13 note, Owens keeps his four-star ratings on General Dynamics, Lockheed Martin, Northrop Grumman and Bombardier, with fair value estimates of US$313 ($400.60), US$539 ($689.85), US$620 ($793.52) and C$134 ($126.42) respectively, all above their traded prices.
Chart: Morningstar
