One time might have been a fluke. Two times, a coincidence. But three times? There can no longer be room for doubt: Boeing
Elaborate, please
I'm sorry. Did I jump the gun? After being chewed out for "burying the lede" last time I discussed the aerospace behemoth's valuation, I wanted to get right to the point this time. But seeing as I am predicting a pretty massive, 33% jump in Boeing's stock price ... a few words of explanation are probably called for. So let's begin.
On Thursday of last week, General Dynamics
During the Bush Administration-boom years for the industry, defense shops often fetched valuations of 1-times sales and up. With the coming of the presumably dovish Obama Administration and general market tremors, however, a lot of folks apparently decided that valuations needed to come down for these companies. And down they came. At one point, in fact, I had the defense industry clocked at 15 points worth of underperformance relative to the S&P 500.
Bargains abound
But that's good news for investors. Here's why: Although more diversified industrial conglomerates such as General Electric
Recent events demonstrate that these discounts are unwarranted, however. It's not just Orbital paying through the nose (and paying over its own price-to-sales (P/S) ratio) to acquire defense and aerospace businesses, you see. To the contrary, in January we saw Argon ST put itself on the block, with experts in the sphere predicting the stock would sell for anywhere from 1 to 2 times sales. A couple months before that, private equity powerhouses KKR and General Atlantic teamed up to take Northrop Grumman's TASC unit private for almost precisely one-time sales.
So everywhere you look, everyone in this industry is paying the pre-2009 valuation for these stocks -- everyone but "the Market," that is.
Time to get busy
On the NYSE and Nasdaq, at least, defense stocks still trade for sizeable discounts to the valuations that savvy acquirers attach to these companies. For example, General Dynamics itself boasts $32 billion in revenues, but a market cap of just over $28.3 billion -- and it's not alone:
|
Company |
Annual Revenues |
Market Cap |
Potential Profit at 1 Times Sales |
|---|---|---|---|
|
Boeing |
$68.3 billion |
$51.3 billion |
33% |
|
L-3 |
$15.6 billion |
$10.7 billion |
46% |
|
Lockheed Martin |
$45.2 billion |
$30.1 billion |
46% |
|
Northrop Grumman |
$33.8 billion |
$19.4 billion |
74% |
A word of caution
Now, I don't want to assume all defense companies are created equal, and should be set to a default pricing level of 1 times sales. For one, Northrop has traded below its peers even in boom-times on a price-to-sales basis. Likewise, Lockheed spent most of the Bush years at the sub-1 P/S level and has recent pension pains that probably justify some haircut to its selling level.
However, I should note that Boeing's been through this exact same situation in 2001-2003 when its P/S ratio dropped all the way down to a mere .40 on commercial aviation fears. In the aftermath of that swoon, Boeing's P/S multiple charged back before program delays and the Great Recession laid it low. However, with recent large defense contract wins and its new airline programs back on track, a repeat of Boeing's mid-decade performance doesn't seem too far-fetched.
Time to get greedy
If these valuations -- and the potential profits they imply -- set you to salivating, then grab yourself a napkin, and take a deep breath. There may be even bigger bargains out there. Even as we speak, Blackstone
This is key because, as the (potential) Argon sale and the actual sales of TASC and the GD subsidiary suggest, a catalyst can go a long way toward unlocking the value of these businesses. More specifically: An acquisition is often needed. And while I am sure there are private equity firms out there that could conceivably raise the funds necessary to "take out" $11 billion-L-3 for example, trying to swallow someone like Boeing, whole, could give an acquirer a serious case of indigestion (not to mention problems getting the merger approved by the Feds.)
In contrast, tiny defense players Force Protection and Henry Brothers present themselves to potential acquirers as relatively bite-sized morsels, while slightly larger firms like Oshkosh and Navistar appear relatively digestible at market caps of roughly $3 billion apiece.
Foolish takeaway
Bargains about in the defense industry, and yes, Boeing itself could easily be a $100 stock. But there's no need to limit yourself to the obvious targets. The smaller companies in this sector not only offer bigger discounts to intrinsic value than the defense majors -- they're easier to acquire, and they offer a better chance of seeing their value unlocked.
My advice: Think defense. But also, think small.
