An Investor's Guide to Space

Get ready for liftoff, space industry -- things are about to change. In this week's previously recorded episode of Industry Focus: Energy, host Michael Douglass and Fool.com contributor Lou Whiteman take a look at the space tech world today -- who the biggest players are, what we know about the projects they're working on, how big the industry really is, and where it could go in the next few years. Tune in to learn which companies could give you the best galactic exposure, why exploration tech is far from a waste of time and money, the biggest risks you need to watch out for, and more.

A full transcript follows the video.

This video was recorded on Aug. 29, 2018.

Nick Sciple: Industry Focus listeners, we've got a special treat for you this week. With Foolapalooza, The Motley Fool's annual gathering of employees from across TMF global offices, we won't be able to record a podcast for you this week. As a result, we're going to the TMF vault to bring you a never before heard episode of Industry Focus featuring former Industry Focus Energy and Financials host, Michael Douglass. Times were simpler back when this podcast was recorded. The S&P was over $2,800. Oil was almost $88 a barrel. Elon Musk had never appeared on a podcast with Joe Rogan. Things were different, OK? One thing that hasn't changed, though, is space. Without further ado, we present to you the last ride of Michael Douglass.

Michael Douglass: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Thursday, and that means its Energy and Industrials. We're talking about space, the final frontier. I'm your host, Michael Douglass. I'm joined by Lou Whiteman. Two notes before we get too far into the weeds. The first one, this show was pre-recorded on August 29th. Some of the things that we're talking about may be a little bit dated as at the time that you're hearing it. Usually, when we pre-record, it's because we don't anticipate major changes happening. But the thing with major changes is, sometimes they're unexpected. That's caveat #1. Point #2: my TMF name is TMFEnterprise, which tells you which way I fall on the great Star Trek versus Star Wars debate. Lou, I don't know where you fall on this, but I think this is something our listeners deserve to know. How do you feel about one of the greatest matches in sci-fi?

Lou Whiteman: Or Star Wars, right? I think I need to be down the middle here. I enjoy both. I don't know if I ever got obsessed with either, but I have watched way too much of both and enjoyed it.

Douglass: I'll go ahead and admit something that I don't usually admit, but hey, why not? In addition to TMFEnterprise, I also have a model of the USS Enterprise on my desk. But I'm also actually very much a Star Wars fan. When I was in middle school, I wrote over 200 pages of Star Wars fanfic, which fortunately was never sent to a publisher. 

Whiteman: Do you still have it?

Douglass: No. Unfortunately. It's really a shame for the literary world, I promise. [laughs] My computer's hard drive died because it was the early 00's. We didn't have cloud storage and things like that, or at least I didn't. So, I unfortunately lost my masterpiece. 

Whiteman: Man. There are so many opportunities now for new shows and networks and stuff. It's the world's loss.

Douglass: [laughs] Yeah. George Lucas, call me. Anyway. We're talking about space today. It's interesting -- I think that when people are thinking about space, you're thinking about Neil Armstrong on the moon, you're thinking about exploration, scientific missions. More recently, due to the advent of companies like SpaceX and Virgin Galactic, we've been talking a lot more about travel, colonization, things like that. And, of course, with Trump's recent moves to launch a space force, I think people are increasingly aware of space's military applications, too.

But the fact is, I think people tend to generally view space as this thing that we're going to do more with at some point. I think that's fair. That's true, that's very likely. But we've also been doing quite a bit with space as it is. I'm not just talking about the Apollo launches and the space shuttles and the various satellites and probes that we put out there, but also things like GPS for the military, which was a major military project and has now been, to some extent, opened up to civilian use.

Whiteman: I'll use another entertainment reference and really show my age. With this space force talk recently, a lot of the mental images have been something out of the James Bond movie Moonraker, where you have astronauts shooting lasers at each other across a huge space battlefield. In reality, there is a lot of military defense space spending right now. Space Force would be a separate place to house it all. Currently, it's mostly out of the Air Force. They have a space missions center out of Los Angeles that does about 85% of what the Pentagon spends in space right now. There are 6,000 people working there. They have a portfolio of assets north of $6 billion. That's just the non-classified stuff. 

In fiscal '19, before all this Space Force talk, the DoD budget includes about $9.3 billion for space programs. About half of that is satellites. You have over $2 billion in launch vehicles and another $2 billion in maintenance. Figure that spending is very conservative. It's probably significantly higher, because a lot of this is classified programs. It's also growing. It was about $7.8 billion in fiscal '18. It was growing even before there was any talk of Space Force.

Douglass: As you noted, and I'll double underline that point, the thing with classified is, we don't know much about it. When you think about cutting-edge research, that's going to be tending to happen in the classified space, because we don't necessarily want to let everyone around the world know all the advantages that the U.S. is working to garner. So, there is probably a fair amount going on there.

Whiteman: Sure. As far as the spending item, given that so much of this is bleeding edge, any research being done is likely very difficult research. You can't just take things off the shelf. You can almost be certain that there are a lot of dollars, maybe an amount equal to what we know about, if you go into research and development of the different labs, the different research institutions, and also the government contractors who do a lot of this R&D. There's a lot we don't know about in this sector in particular.

Douglass: Yeah. The broader picture of all this is that this spending has been rising, and it's going to keep rising. 

Whiteman: It has to.

Douglass: As we were talking about before here, the status quo of the U.S. being unchallenged in space is over. Russia is doing quite a bit. China is doing quite a bit. We're actually behind in some areas, particularly hypersonics, which is about traveling at 5X the speed of sound.

Whiteman: I think it's fair to say the United States rested on his laurels. We won the space race. We had the space shuttle. Russia was going through the breakup of the Soviet Union. We were the undisputed leader for a long time. And as a result, we slowed down our pace of innovation. As you say, that is no longer the case. Hypersonics is a perfect example. These are missiles that are capable, due to their speed, due to their maneuverability, they travel in low space and they are basically unstoppable with any technology we have. Russia claims they have a system in place. China is very close. We are way behind. The Air Force has given out about $1.4 billion in contracts this year, all to Lockheed Martin, to try and play catch up. They are determined to make it a quick catch-up. But, yes, there and in other places. Where we were the only power for a long time, now, the systems we have are vulnerable and arguably, in a lot of areas, research being done elsewhere, if not matches what we're doing, exceeds it, in terms of what they've been able to develop.

Douglass: Yep. There's quite a bit going on here. There are also some significant non-military applications. Lockheed has a NASA contract to develop a Concord replacement. Northrop Grumman (NOC 2.84%) is working on the James Webb Space Telescope. I think you said it was going to cost them $10 billion or so before it launches.

Whiteman: All in, yes.

Douglass: And, of course, there's manned missions, too.

Whiteman: Right. And part of this, as you say, is that all of this stuff, I don't know if it's necessarily the first thing people think about with the defense contractors, but the defense contractors are front and center in all of these things. Like you say, Lockheed, Northrop Grumman, Boeing Space is a huge division. Boeing and SpaceX, the Elon Musk start-up, they both developed capsules that NASA is going to use to carry astronauts to the International Space Station, hopefully very soon. There's been a lot of delays there. But, yes, NASA is doing a lot of work. Due to NASA's size and capabilities right now, a lot of the R&D that they do, they outsource to, again, research institutions, but a lot of it is to the private sector. NASA's overall budget was about $19.5 billion. They're spending $10 billion right now on exploration, which is the cutting-edge stuff, returning to humans to the moon, and eventually all this talk with Mars.

Douglass: One of the things that's important to note here is, there's always this question about, "Exploration, what's that really worth?" What's all this science stuff worth? I think one of the things that people often forget is that a lot of innovations come because of that. When you're having to figure out how to keep somebody alive in zero G, or to scrub out carbon dioxide, things like that, that creates inventions that can be very useful and have a lot of military and civilian applications. There's a lot to think about there in terms of benefits.

Whiteman: Right. And a lot of that, we don't realize until after the fact, which is why it's so important to do the research. NASA is hoping to have humans on the moon by the middle part of the next decade. A lot of the tech that they're counting on toward that goal, which is not very far off, is still in development. The Space Launch System, a massive new rocket that is going to be needed to set up the midpoint station -- the idea is that there would be a separate station orbiting the moon. We can build that, but to get it into orbit, we need a rocket that is still in the development phase. Here we are, halfway through 2018, and they hope to be doing it by 2024. The amount of research needed -- and, as you say, the benefits that will come from that from all sorts of ways we can't anticipate -- history has shown that that happens, and it will come. It's really hard to look at right now as we're looking forward, but I don't doubt that there is payback in these investments in ways that we can't even imagine right now.

Douglass: Let's turn back to this whole space thing, which is a pretty big opportunity. Let's talk about what the current big players look like. 

Whiteman: It's somewhat hard to look on the fence because it's coming from so many different areas. But I think we can pretty safely say that the companies we're going to talk about with NASA are also the biggest players for defense. Fiscal 2017, the top NASA contractor was actually a university, which shows how much R&D goes into this. Following that was Boeing with over $2 billion in procurements; Lockheed with $1.4 billion; then, again, SpaceX, the start-up that's doing a lot of the launching work. Orbital Science, which was acquired by Northrop, they were #5. Northrop was also in the top 10. Raytheon is there. A company called a Harris, which is under the radar but does a lot of work in space. These are all top ten contractors to NASA. They're all doing a lot of work for the Defense Department.

Douglass: It's seems very clear to me that the strategy on the government side has been to try to spread things around as much as possible. You don't want to have a single point of failure. You don't want to have one company that has everything locked up. Instead, what you want is a bunch of different folks working toward this goal so that the public side isn't suddenly completely dependent on one private player. So, they can make sure there's an open market and a lot of innovation going on.

Whiteman: That's an important point. It's actually something that's often discussed in government circles. The downside with that is, you're sometimes developing redundant systems, or you're funding research where you know one of the two candidates may not make it. That's an expensive process. But given that a lot of this stuff has never been done before, there is a desire inside the government to have multiple parties working on it, multiple failures, multiple experiments. That is a great opportunity for these companies. These things aren't cheap, and for all of the goals we have, part of the reason that they are so expensive is that there's so much work that goes into it from multiple parties. From a business case, it's a great business to be in.

Douglass: Right, because ultimately, spending is going to keep increasing. As various international powers scale up and identify certain companies that are doing well or certain gaps in their systems and things that they need, that will give these defense contractors a lot of opportunity to develop a lot of really good hardware and a lot of great science in a lot of different places for a lot of different clients.

Whiteman: There are also continued opportunities to expand. Northrop, I mentioned, bought Orbital Sciences for almost $10 billion. That's a major deal. That's going to reshape Northrop. It shows what that executive team thinks of the future of space. They've decided that space is going to be a priority. There aren't too many other Orbital Sciences out there for these big guys. There are some companies that might fit nicely into a portfolio. But I think Northrop signaled their intention, and I don't think they're alone in thinking how important space is. They didn't go out and buy a land systems maker. They didn't go out and say, "Let's get big into tanks." They're investing in space because they see it as an opportunity for growth. I don't think many executives at these other contractors would question that line of thought. I think that should be a tell for investors, as far as where these companies see spending increasing.

Douglass: I think that's fair. To some extent, in markets, folks are going to follow the money. That's why we're seeing so much of this. Northrop going after Orbital, and also these start-ups, whether it's SpaceX, whether it's Virgin Galactic, or Bezos' Blue Origin. They're all trying to find ways to play in this space and get a chunk of this ever-increasing pie.

Whiteman: Sure. Elon Musk has been really smart about this. As much as the focus on Blue Origin and SpaceX is going to Mars and space tourism and stuff, these systems are expensive to develop, and the government is a reliable customer. SpaceX has done very well from earning the trust of the government and getting these contracts. That pays for a lot of the R&D. That's the interesting thing, if you look at it, for investors here. While there are wonderful opportunities, there's also a lot of companies, an increasing number of companies, going after this pie. Northrop's buy for Orbital, part of that is this, they'd like to move into this area, the heavy launch area, where right now, a joint venture between Boeing and Lockheed is competing with SpaceX. That competition is going so well that the joint venture, United Launch Service, has done layoffs, they've done cutbacks, and they're complaining about, they aren't getting the margins they need to sustain a business. Well, Northrop with Orbital is going to make that a lot more complicated. 

While there is a lot of spending, and it's going to increase, just a little word of caution, especially for these companies that are too reliant on it, that it isn't just part of the business -- there's also a lot of competition now. There's a lot of people following that money.

Douglass: Yeah, absolutely. If you're thinking about the space area, one of the key things to think about here is that there aren't really a ton of publicly traded pure plays. Really, the opportunity is to look at a large, diversified company and see space as a part of that, as an opportunity within that company. Of course, there are two big caveats that come with that. The first one is: that large company, whatever it might be, has a bunch of other divisions. Before considering, "So-and-so is playing in space, I'm really excited about them," you want to make sure that you're also excited about the rest of what they're doing, too. If you're not, that may mean that they fail to compete well, etc., etc. In a case like that, it's hard to pick one company over, say, an ETF. 

The second caveat that I'll throw out there is that it's early days. Yes, we've been in space for a long time. Obviously, these companies have been scaling up what they're doing in space for a while. But we're in the early days of a lot of really big ideas and a lot of big expansions. Trying to pick a winner right now, pretty darn difficult, particularly given that so much is classified. The way to think about that is, that that does make it very difficult to pick winners versus losers. That's just something to keep in mind as you're thinking about investing in this space.

Whiteman: Sure. The funny thing is, the nature of space is, it's always early days. The second we get to the moon, then you can look to Mars, etc. There's a lot of risks, both for the astronauts and for the companies making the capsules. But there's so much opportunity there, as long as it is a focus. Be it because of the military's interest and need, and NASA's interest and their funding levels, there is the opportunity there.

Douglass: I have to ask. Which happens first: permanent colony on the moon, permanent colony on Mars?

Whiteman: The moon. The scale of the challenges, it's so much easier to get to the moon. If nothing else, the moon is a good place to learn and fail and learn again. Hopefully not fail. Our ability to get back and forth to the moon, even right now, if we had to, it makes it a great training ground. Frankly, unless we figure out a new propulsion system -- if you go back to high school physics, it's tough to get through the Earth's gravity. If we could launch something for a long-range mission from the moon, instead of launching it from the Earth, the amount of fuel you'd need would be greatly reduced. It would make the whole process so much simpler. I have no doubt in my mind we'll be on the moon before we'll be on Mars.

Douglass: You heard it here first -- well, maybe not here first, but you heard it here. [laughs] Folks, that's it for this week's Energy and Industrials show. Questions or comments, you can always reach the team at [email protected]. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Lou Whiteman, I'm Michael Douglass, thanks for listening and Fool on!

As of the time that you're hearing this show, Michael Douglass works for Motley Fool Wealth Management LLC, an affiliate of the Motley Fool LLC, an investment advisor registered with the U.S. Securities and Exchange Commission. The views expressed herein are those of Mr. Douglass and do not necessarily reflect the views of Motley Fool Wealth Management or any of its affiliates. These comments may not be relied upon as recommendations financial or investment advice or an indication of trading intent.