The United States is plotting its most aggressive expansion of missile defense capabilities since the Cold War. It's going to take time for exact details of the plan to be worked out, but among defense companies, there are some pretty clear winners -- and a few potential losers -- likely to come out of this new Pentagon push.
The new Missile Defense Review, unveiled at the Pentagon on Jan. 17, attempts to move U.S. policy away from focusing on deterrence -- the threat of a counterstrike -- and toward more active defense measures and specific technologies designed to counter threats. It leans on some existing tech but would require massive spending on research and development to modernize those technologies and develop new, currently only theoretical capabilities.
The document is more of a road map than a specific list of funding plans or procurement options, and therefore it is too soon to update company revenue estimates based on the plans. But it is bullish for defense stocks because it shows a dire need for investment and offers clues as to who is best positioned to capitalize.
Using the tools in place
Although the review is new, the Pentagon has been investing in missile defense for decades, and the work done by Lockheed Martin (LMT 1.98%) and Raytheon (RTN +0.00%) positions those contractors well to be among the top beneficiaries of this new push.
Check out the latest Lockheed Martin and Raytheon earnings call transcripts.
The Pentagon wants to fortify its attack capabilities by better integrating those efforts with missile defense. That requires continued investment in programs including Lockheed's Terminal High Altitude Area Defense (THAAD) antiballistic system, which uses a Raytheon-made radar system, as well as Lockheed's Aegis Combat System, a collection of computer and radar technology designed to track and guide weapons to destroy enemy targets.
Lockheed Martin's THAAD antiballistic system launches over water. Image source: Lockheed Martin.
Raytheon's SM-3 IIA interceptor, which is currently designed to work against mid-range missiles, will also be tested against faster and higher-altitude intercontinental ballistic missiles. The U.S. is even considering equipping Lockheed-made F-35 Joint Strike Fighters with a weapon that could cripple a ballistic missile during its launch phase, potentially opening up new missions, and possibly more demand, for the high-tech fighter.
The review also notes the Pentagon's growing concerns about hypersonics, missiles that reach high elevations and travel at more than five times the speed of sound, as well as maneuverable cruise missiles that are able to zigzag in flight and are therefore much harder to target.
Lockheed has won more than $1.5 billion worth of hypersonics contracts in the last year, and the Pentagon, in justifying one of the awards, said that "no other contractor has this level of design maturity," estimating it would have cost the government more than $100 million in duplicate development costs had it selected any of Lockheed's rivals.
Weaponizing space
Some aspects of the plan require technologies that are not yet viable and would involve the United States taking the controversial step of mounting weapon systems in space. While spy satellites and sensors have been deployed for decades, the move toward placing actual weapons in orbit, while seemingly inevitable, is controversial.
It is also far from certain. Expect the Pentagon to spend the next few years running tests and investing in research to determine the viability of space-based interceptors, including a variety of lasers and more conventional rockets.
Much of this work to this point has been theoretical, and what companies are doing is largely classified. But missions like this are a key reason Northrop Grumman (NOC 1.83%) spent $9.2 billion to buy Orbital ATK last year.
Check out the latest Northrop Grumman earnings call transcript.
The Pentagon is also moving forward with development of a new space-based sensor layer to complement the U.S.'s existing detection capabilities. Congress authorized funding to study and develop a system in fiscal 2019, with the hope of demoing some form of a new capability to detect and track missile launches by the mid-2020s.
Defense researchers are expected to consider a range of possibilities, including massive and expensive military-grade satellites like ones the Pentagon already has in orbit, a cluster of smaller, less-expensive satellites capable of providing broad coverage on the cheap, or even sensor payloads attached to future commercial satellites.
While the exact path is unclear, prioritizing space sensors should create growth opportunities for a range of companies including Boeing (BA 2.23%) and Harris (HRS 1.63%).
Check out the latest Boeing and Harris earnings call transcripts.
Shipbuilders beware
Moving detection capabilities to space would be a major relief for the U.S. Navy, which has complained that it is stretched thin because of the need for it to deploy its Arleigh Burke class of guided missile destroyers equipped with Aegis combat system technology to provide better missile detection across the Pacific.
In theory, lessening the Navy's responsibility for missile detection would free up ships for other missions. But doing so could also weaken the Navy's case for expanding its fleet by more than 25% to 355 ships. Naval officials would likely accept that trade-off, but it would eat into some of the bull case for shipbuilders Huntington Ingalls (HII 1.00%) and General Dynamics (GD 2.58%).
Check out the latest Huntington Ingalls and General Dynamics earnings call transcripts.
The Pentagon is in expansion mode, floating plans to rapidly expand the Air Force and modernize Army ground systems in addition to the Navy's desired buying binge and a new emphasis on missile defense and space. But with budget battles on the horizon, it's tough to imagine that the entire wish list getting funded and lowering the Navy fleet goal while gradually reducing the branch's obligations would be a logical way to get the most bang for the buck.
That's not to say there is no growth in shipbuilding: Huntington Ingalls is likely to soon get a massive deal to build two new aircraft carriers, and General Dynamics' new Columbia-class nuclear missile submarine is a vital part of the nuclear triad. But if space systems can take on some of the mission currently done by destroyers, the growth might not come in as high as some had hoped.
Missile defense is a long-term trend
It's important to reiterate that this document is a road map and not a shopping list. It lays out the framework for a long-term Pentagon budget conversation but will not impact any contractor's bottom line this quarter.
No one should go out and buy Lockheed Martin shares expecting a near-term pop based on the Pentagon's emphasis on missile defense. That said, long-term owners of Lockheed Martin and its brethren can comfortably view missile defense as a source of long-term growth for the sector.
Given the level of threat the Pentagon has identified, missile defense spending seems likely to rise in the years to come regardless of the overall budget outlook.
