The Trump Effect: 2 Under-the-Radar Defense Stocks

The Trump rally in the U.S. stocks rolls on. Leading the way are the market sectors most likely to receive a boost from the expected policies of a Trump administration.

In my view, foremost among these sectors – along with infrastructure – is the defense sector and defense stocks.

The defense sector hasn’t exactly suffered in the Obama administration. The U.S. spent more than $600 billion on defense in 2015.

But spending on defense was restricted under the Budget Control Act of 2011. The so-called sequestration imposed a $500 billion, 10-year cut to defense spending.

Trump’s Own Words

However, defense spending under Trump will likely receive a boost. One needs look no further than what Trump said as a candidate.

First, in a March campaign speech, Trump said “I’m gonna build a military that is gonna be much stronger than it is right now. It’s gonna be so strong nobody’s gonna mess with us.”

Then, in a September campaign speech, Trump highly criticized both Hillary Clinton and President Obama for allowing defense spending to track to levels as a share of the U.S. economy not seen since the end of World War II.

He said, “We currently have the smallest Army since 1940. The Navy is among the smallest it has been since 1915. And the Air Force it has been since 1947.”

In the same speech, Trump called for 90,000 additional soldiers, 100 more modern fighter aircraft and 42 more Navy ships.

Many analysts forecast Trump’s plans will mean from $90 billion to $100 billion a year more than levels set by the Budget Control Act. That is a win for the defense industry.

Defense Stocks: Big Names and Hidden Issues

Of course, everyone is familiar with the big names in the sector including Lockheed Martin (NYSE: LMT), Raytheon (NYSE: RTN), General Dynamics (NYSE: GD), Northrop Grumman (NYSE: NOC) and Boeing (NYSE: BA).

So for something different, here are two under-the-radar defense stocks.

Defense Stocks: Shipbuilding

There is an old adage that says “a rising tide lifts all boats.” That looks to be especially true under Trump for anything connected with the U.S. Navy. Trump and his hawkish Cabinet choices, such as Defense Secretary nominee General James ‘Mad Dog’ Mattis, are all in support of expanding the Navy.

This probably benefits no company more than Huntington Ingalls Industries (NYSE: HII).

It has become a successful standalone company since its spin-off from Northrop Grumman in 2011. The company was formerly known as Northrop Grumman Shipbuilding. It was formed in 2008 by a merger between Northrop Grumman Ship Systems and Northrop Grumman Newport News.

Huntington Ingalls pretty much has one customer – the U.S. government in the form of the Defense Department, the U.S. Navy and the U.S. Coast Guard.

The company is the sole builder of nuclear-powered aircraft carriers. It also builds nuclear submarines and is the largest supplier of U.S. Navy surface combat ships, such as guided missile destroyers. And HII is a major supplier of amphibious ships, including the Navy’s latest San Antonio class amphibious assault ships.

The company has managed to improve its profit margins since the spin-off to 11% from 6%. While revenues haven’t risen much since the spin-off ($6.6 billion to $7 billion), the backlog of $22 billion as of the end of 2015 is solid.

The balance sheet is very solid too. After including the $1 billion in cash held, the net debt is only $300 million.

With more business thanks to Trump, I’d expect the company to continue raising both its cash dividend and stock buybacks.

Defense Stocks: Speculative Defense Play

The next stock is much more of a speculation – a niche defense company called Kratos Defense & Security Solutions (NASDAQ: KTOS).

In fact, the bears on the company say it will go to zero because of its high debt level. But I think they are missing the fact that the U.S. government is shifting its military focus from ground combat to one more high-tech. That is, a greater focus on things like missiles, drones and lasers.

One area of focus for Kratos is lasers. In 2010, it was given a contract to develop a laser weapons system (LaWS).

There is one LaWS deployed in operational status on board the forward staging base ship, the USS Ponce. Since 2014, the captain of that vessel has been authorized to use the weapon defensively. The weapon can fire a 30 kilowatt directed energy beam that can bring down drones, helicopters as well as disable smaller boats.

Kratos looks to not only get more lasers onto naval vessels but also expand the laser systems into missiles. A big part of the future of missile defense will center on lasers.

Another area of focus for Kratos is drones. In fact, most of the debt it incurred was to develop its own drone – the UTAP-22 – without government assistance.

It is a superior drone. It is faster, traveling at Mach 0.91. And it’s smaller, just 20 feet long and with a 10-foot wingspan.

Its competition comes the private firm, General Atomics, and its Reaper drone. The Reaper is 36 feet long and has a 66-foot wingspan. Its top speed is only 230 mph, well below Mach 1.

The difference is that the Reaper is designed to fly in threat-free environments. That sounds almost superfluous for the military.

The UTAP-22 operates more like a fighter aircraft and can operate independently or in conjunction with manned aircraft. It successfully completed a test flight in December 2015 in conjunction with a Marine Corps AV/8B.

In addition, Kratos has other segments. These include cyber security and warfare, microwave electronics, satellite communications and training solutions for flight crews, etc. All of these segments should receive a boost if defense spending rises.

Both companies and both defense stocks should enjoy a major boost in the upcoming Trump Administration.

Published by Wyatt Investment Research at