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Analyst Picks: Should You Buy This Under-the-Radar Underwater Defense Company?

By Rich Smith – Oct 30, 2017 at 1:55PM

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Merrill Lynch likes Curtiss-Wright as a play on Navy submarine fleet growth.

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope.

Shares of industrial company Curtiss-Wright Corporation (CW 0.68%) have beaten the S&P 500 by 8 percentage points over the past 12 months. They're beating it again today, rising more than 1% as the rest of the market trends downward -- and for this you can thank the friendly analysts at Bank of America/Merrill Lynch.

Here are three things you need to know.

A submarine

The U.S. Navy loves submarines -- and Merrill Lynch loves Curtiss-Wright stock. Image source: Getty Images.

1. A bit of history

As an aerospace and defense writer, I spend a lot of time watching and writing about defense companies, but one I have not written a lot about to date is Curtiss-Wright.

Why not? Historically, Curtiss-Wright was best known as an airplane manufacturer. Wall Street Journal contributor A.J. Baime, in his 2014 investigation into American industry's role as The Arsenal of Democracy in World War II, describes how Curtiss-Wright became the country's second-largest defense contractor, producing P-40 Warhawk fighter planes and helping Ford with quality control on its B-24 Liberators for the U.S. Army Air Corps. In the years since, however, Curtiss-Wright has faded into the background, getting out of the business of building entire airplanes, focusing instead on the production of specialized parts for use in aerospace -- and for commercial industry and for the Navy as well. In the process, it fell off my radar as a first-tier "defense company" name.

2. What Curtiss-Wright does today

Merrill Lynch hasn't forgotten about Curtiss-Wright, though. In today's upgrade, Merrill Lynch is endorsing Curtiss-Wright as a play on the rebuilding of the United States Navy's nuclear submarine fleet. As explained in a write-up on the TheFly.com, Merrill Lynch notes that Curtiss-Wright is the sole-source provider of coolant pumps for U.S. Navy nuclear submarines (and nuclear aircraft carriers, too). The company also provides "off-the-shelf embedded computing board" modules and integrated subsystems used in nuclear submarines.

The U.S. Navy has embarked on a project to build dozens of new and replacement nuclear submarines for its fleet. In Merrill's view, the Navy's "push to increase procurement" of submarines creates a path to long-term growth for Curtiss-Wright -- growth that StreetInsider.com points out should outpace the growth rate of the U.S. defense budget at large.

3. Is Curtiss the right stock for defense investors?

How fast could Curtiss-Wright grow? S&P Global Market Intelligence figures show most analysts predicting an 11% rate of long-term earnings growth for Curtiss-Wright stock. Merrill Lynch believes this justifies assigning a "buy" rating to the stock, with a $136 price target. If the analyst is right about that, Curtiss-Wright shares offer new investors the prospect of earning about a 16% profit from today's prices -- plus a modest 0.5% dividend.

But here's the thing: Currently, Curtiss-Wright stock costs significantly more than the valuations being assigned to the stocks of General Dynamics (GD 0.47%) and Huntington Ingalls (HII 1.73%), the two largest companies in the nuclear submarine space. At 26.6 times trailing earnings and 2.4 times trailing sales, Curtiss-Wright stock sells for about a 20% to 30% premium to the valuation of General Dynamics (20.4 times earnings, two times sales ratio). It's even more expensive relative to the valuation of Huntington Ingalls, which costs only 19 times trailing earnings and 1.5 times trailing sales.

What's more, analysts predict General Dynamics will grow nearly as fast as Curtiss-Wright (10% projected earnings growth rate), while Huntington Ingalls will grow several times faster. Huntington Ingalls stock is in fact projected to grow earnings in excess of 27% annually over the next five years.

What this all means to investors

Even if Merrill Lynch is correct about the growth prospects for the U.S. naval submarine fleet, and about Curtiss-Wright's prospects for profiting from this growth, Curtiss-Wright stock costs significantly more than the more obvious on this growth trend.

The moral of this story: You don't always have to seek out an under-the-radar stock to profit from big trends in the defense industry. Sometimes, the more obvious stocks offer the better values. In this case, General Dynamics and Huntington Ingalls stocks are better values than Curtiss-Wright.

Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Curtiss-Wright Stock Quote
Curtiss-Wright
CW
$176.65 (0.68%) $1.20
General Dynamics Stock Quote
General Dynamics
GD
$252.39 (0.47%) $1.17
Huntington Ingalls Industries Stock Quote
Huntington Ingalls Industries
HII
$231.96 (1.73%) $3.94

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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