How to Profit From U.S. Budget Cuts

Making money on DoD budget cuts.

May 27, 2014 at 9:58AM

A large part of the U.S. government's upcoming budget cuts will come from the Department of Defense. The fiscal year 2015 budget says the DOD will seek to lower the number of soldiers in the military to make the necessary budget cuts. This loss of soldier power can be made up for in technological advances. The FY 2015 budget explains: "The Opportunity, Growth, and Security Initiative would allow DOD to accelerate the schedules for developing and buying new or upgraded systems in order to ensure that the United States maintains technological superiority over potential adversaries. For example, it provides enhanced resources for procurement of manned and unmanned aircraft, helicopters, ground vehicles, and communication systems."

This part of the DOD's budget contains $26.4 billion; simply put, a lot of money will be invested in companies that make these technologies. Fortunately for us Fools out there, many of these companies are publicly traded.

Who will be making the money?
My first pick isn't quite traditionally Foolish. AeroVironment (NASDAQ:AVAV) makes all types of unmanned aerial vehicles, or UAVs, for military and civilian applications. It makes four small UAVs, the most popular being the Raven (which I've seen in action, so I can vouch for its applicability). AeroVironment also produces a man-portable UAV missile and a high-altitude, long-endurance UAV. It's also a leading producer of electric-vehicle recharging solutions, recently contracting with Fiat to provide home charging stations for Fiat's new electric vehicle. While AeroVironment is extremely popular in the military world, it has yet to gain a foothold in the civilian market, as UAVs have not yet been recognized for their time- and cost-saving potential. In 2013, AeroVironment was awarded $114.1 million in contracts for its systems proving it's ability to create a steady revenue stream . While the company's relationship with the DOD should continue to be lucrative, the civilian sector is growing, and current applications include fire fighting, studying disasters and weather, search and rescue, crop monitoring, consumer shipping (Amazon's aerial delivery idea), and environmental protection. AeroVironment is a diversified company breaking into the civilian market, but its stock is overvalued at 149 times earnings, putting it at risk for a price correction. An investment in AeroVironment, while potentially profitable, will be riskier than your average Foolish choice.

Next up is Textron (NYSE:TXT), best known for the Shadow UAV, which is currently used by the U.S. Army and Marine Corps, the Australian Defense Force, and the Swedish and Italian Armed forces. In 2012 AAI Corp, the Textron subdivision that produces the Shadow, was awarded a $358 million contract to upgrade Shadows for the U.S. Army and Marine Corps, with deliveries starting in late 2013. AAI also won a multi-award contract in 2012 worth up to $874 million, allowing the DOD to place orders over the next five years. Textron also owns and operates Bell Helicopters; Lycoming, which accounts for half the world's general aviation engines; three major plane brands; Kautex, a top-100 worldwide automotive supplier; Jacobsen, maker of turf maintenance equipment; E-Z-GO golf carts; and a product financing business. Textron is a diverse company with long-term growth potential in the military-industrial complex and multiple civilian-based industries, and it's fairly valued with a P/E of 24, making it look worthy of further investigation.

Last but not least, we have Boeing (NYSE:BA). Boeing is by far the largest of these three companies, outselling Textron by at least $74 billion, mainly because Boeing's largest customer is the world's airline industry. Boeing has a backlog of almost 5,000 aircraft, worth hundreds of billions of dollars. Its second-biggest customer is the military-industrial complex, with products ranging from satellites to ground vehicles. Boeing has won a large contract for its new naval warfare reconnaisance plane, the P-8A Poseidon, a variation of the Boeing 737 that is filled to the brim with state-of-the-art anti-submarine and surface warfare equipment. It has produced 53 of the aircraft, worth a total of $9.6 billion, and has the potential to produce 64 more. While Boeing is a mainstay in the fixed-wing and rotary-wing market with aircraft like the B-52, Apache, C-130, C-17, Chinook, and F-15/18, it's expanding its product line into UAVs, which have a multitude of applications in the military and civilian world. Boeing is also looking reasonably valued with a P/E of 23. You might consider buying if you believe in Boeing's long-term growth strategy. 

Foolish bottom line
Many of the companies that develop U.S. defense equipment also develop civilian equipment. The ability to market to both civilian and military customers makes the military-industrial complex a great long-term investment. 

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Grant Perry has no position in any stocks mentioned. The Motley Fool recommends AeroVironment. The Motley Fool owns shares of AeroVironment and Textron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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