Defense Stocks: Which Stocks Are Vulnerable to Budget Cuts?

Defense budget cuts have been in discussion for some time, and although nothing is yet written in stone, there have been some significant developments. Here's what you need to know.

The budget battle
The Pentagon has agreed to cut $450 billion over the coming decade from the roughly $7 trillion it expected to receive. Likely targets are military health care and retirement accounts, cuts in the number of troops on active duty, and a reduction in the Pentagon's planned $350 billion buy of more than 2,400 F-35 fighters, according to Time.com.

More pressing for the Pentagon is the prospect of doubling the cuts (up to $900 billion or even $1 trillion) if the Super Committee fails to come up with the necessary $1.2 trillion in deficit reductions by November 23rd. This is due to a process called "sequestration" created under the Budget Control Act that originally established the committee in August.

Sequestration would not begin until January 2013, giving Congress a full year to alter the budget (or change the law) and avoid the additional budget cuts. This provides some much needed hope for the Pentagon which has said it cannot make the additional cuts without hurting national security. According to Defense Secretary Leon Panetta, "If personnel accounts were protected, everything else would have to be cut by 23%."

Investing ideas
Although the Super Committee is not micromanaging where budget cuts are being made, many fear the committee will try to wring more savings out of the Pentagon to help add up the numbers.

Interested in tracking trends in the defense industry? We've managed to identify six aerospace/defense stocks that have a history of outperforming their competitors on profit margins.

These are some of the most profitable companies in the defense industry -- will the market start dumping these names if defense spending is cut?

Use this list as a starting point for your own analysis. (Click here to access free, interactive tools to analyze these ideas.)

List compiled by Eben Esterhuizen, CFA:

1. BE Aerospace (Nasdaq: BEAV  ) : Engages in the design, manufacture, sale, and service of commercial aircraft and business jet cabin interior products worldwide. TTM gross margin at 39.76% vs. industry average at 25.34%. TTM operating margin at 17.17% vs. industry average at 11.69%. TTM pretax margin at 11.83% vs. industry average at 6.03%.

2. Breeze-Eastern (NYSE: BZC  ) : Designs, develops, manufactures, sells, and services lifting and restraining products for specialty aerospace and defense applications. TTM gross margin at 43.05% vs. industry average at 25.34%. TTM operating margin at 12.15% vs. industry average at 11.69%. TTM pretax margin at 11.34% vs. industry average at 6.03%.

3. Esterline Technologies (NYSE: ESL  ) : Designs, manufactures, and markets engineered products and systems primarily for the aerospace and defense market, as well as for industrial/commercial and medical markets in the United States and Europe. TTM gross margin at 39.57% vs. industry average at 25.34%. TTM operating margin at 13.87% vs. industry average at 11.69%. TTM pretax margin at 11.92% vs. industry average at 6.03%.

4. Honeywell International (NYSE: HON  ) : Operates as a diversified technology and manufacturing company worldwide. TTM gross margin at 28.99% vs. industry average at 25.34%. TTM operating margin at 12.43% vs. industry average at 11.69%. TTM pretax margin at 9.52% vs. industry average at 6.03%.

5. Hexcel (NYSE: HXL  ) : Engages in the development, manufacture, and marketing of composites for use in the commercial aerospace, space and defense, and industrial applications. TTM gross margin at 28.16% vs. industry average at 25.34%. TTM operating margin at 12.45% vs. industry average at 11.69%. TTM pretax margin at 11.6% vs. industry average at 6.03%.

6. Teledyne Technologies (NYSE: TDY  ) : Provides electronic components, instruments, and communications products in US. TTM gross margin at 36.27% vs. industry average at 25.34%. TTM operating margin at 12.09% vs. industry average at 11.69%. TTM pretax margin at 10.84% vs. industry average at 6.03%.

Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.


Kapitall's Eben Esterhuizen and Rebecca Lipman do not own any of the shares mentioned above. Profitability data sourced from Fidelity.

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