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Over the course of a 34-minute speech to cadets at West Point Tuesday night, President Barack Obama laid out the reasons why 71,000 U.S. troops are currently fighting in the mountains of Afghanistan -- and some things we aren't there to do, and how much longer we will remain.
We're in Afghanistan to prevent a repeat of 9/11, and to support the Afghan government until it can support itself and protect its citizens from the Taliban. We're not there to wage war on Islam, or to occupy a foreign land and create an American empire. Accordingly, we're not going to be there forever.
I'll leave the geopolitical analysis of the president's speech to others. Today, I'll talk only about the implications for investors.
A 50% gain in troop strength
Thirty thousand is the headline number in this regard. The President intends to send 30,000 U.S. troops to reinforce the contingent already there, bringing U.S. troop strength to roughly 100,000.
In addition, the U.S. will encourage its NATO and other allies to send 5,000 to 10,000 troops to bolster their own commitment, which currently numbers 38,000. Conceivably, if the allies don't ante up as much as hoped, the 40,000-troop increase that General McChrystal has called for could require the U.S. growing its forces as much as 50%. But any way you look at it, there's a sizeable increase in store.
A wise man once asked: "War! (Huh-yeah.) What is it good for?" Well, defense contractors, for one. So which defense companies are set to profit most from our renewed commitment to the Afghan fight?
The obvious answers might not be the right ones. For example, Navistar and General Dynamics (NYSE: GD ) both make MRAP armored trucks geared toward protecting troops from roadside bombs. But while Afghanistan has its fair share of hidden bombs to contend with, what it's lacking in are actual roads. Rival MRAP-maker Oshkosh (NYSE: OSK ) has won contracts to build 6,219 all-terrain MRAPS (M-ATVs), and announced Tuesday the successful delivery of its 1,000th M-ATV to the military. A near-50% increase in the U.S. troop commitment could easily see the M-ATV program top out its initial projection of a maximum 10,000 vehicles ... or not.
"As [the Afghans] stand up, we'll stand down ..."
In shades of the Iraq war plan (and Korea, and Vietnam, and on and on ...) President Obama made "Afghanization" a centerpiece of his new war plan. Additional troops deployed to the theater next year will "target the insurgency and secure key population centers" -- both jobs for which MRAPs and M-ATVs will come in handy.
But their real and ultimate objective is to "help create the conditions for the United States to transfer responsibility [for this war] to the Afghans." The increase of U.S. troops in Afghanistan aims to push back the Taliban, giving the Afghan army breathing room to train up an additional 150,000-plus troops, nearly tripling its size to 250,000.
Considering that the president aims to start rolling back the troop increase as early as 18 months after it begins, I can't help but wonder how much the Pentagon will want to spend on theater-specific weapons systems like M-ATVs, which have limited uses outside of Afghanistan. As such, investors might be better off focusing less on the weapons-makers, and more on the troops-trainers, with training local troops being the real objective of the administration's policy.
Companies with experience running large, complex defense projects in a coordinating role -- firms which include General Dynamics, but also names less-associated with boots on the ground, like aerospace titans Boeing (NYSE: BA ) , Lockheed Martin (NYSE: LMT ) , and Northrop Grumman (NYSE: NOC ) -- might be better suited to win contracts to facilitate the training. Similarly, government contractors such as L-3 Communications (NYSE: LLL ) and SAIC (NYSE: SAI ) both have significant experience running major military logistical contracts in Iraq.
Just one stock
In fact, if I had to pick just one stock best-placed to benefit from the troop increase, it would be one of these dark-horse candidates: L-3. Reading between the lines of the President's plan, it seems to me that the clear intent is to return this fight to the Afghans. Troop increases get the headlines, but troop withdrawals, and training up the locals, are the real story here. L-3, with its years of experience training U.S. soldiers at home and abroad and of running intelligence and translation services for the U.S. Army in both Iraq and Afghanistan, seems ideally positioned to win further contracts to perform similar services as the Afghan training effort ramps up.
Granted, priced at less than 10 times earnings and with long-term growth currently projected at just over 9%, L-3's stock isn't an obvious bargain. But this stock is cheaper than meets the eye, boasting free cash flow that exceeds reported GAAP earnings by nearly 20%, and built-in advantages that could help it win new contracts -- boosting its growth rate.
Last but not least, L-3 shareholders can enjoy a modest 1.8% dividend yield as they wait to see how Mr. Obama's plan for Kabul evolves. Does this make L-3 a defensive defense pick? Indubitably.