Great news, America! Dennis Rodman met North Korea's Communist dictator, Kim Jong-un and said, "He's a really good guy." Well, that's a relief. Now we can all forget about the rampant human-rights violations, the mass famine, and the fact that North Korea's supreme military body just announced that it wants to launch a pre-emptive nuclear strike against the U.S. and turn D.C. into "a sea of fire."
You read that right. Instead of backing down because of new sanctions, North Korea has retaliated by issuing more threats against the U.S. and South Korea. While this news may appear to be coming at exactly the wrong time, specifically because of sequestration and defense cuts, there are a few things you should know.
First, North Korea has successfully tested intercontinental ballistic missiles, has carried out nuclear tests, and has moved mobile missile launchers into strategic positions. The nation has done all of this in spite of condemnation from the UN, the U.S., and even ally China. North Korea isn't playing around. It wants the U.S. dead and gone, and it has since 1950.
Second, if push comes to shove, America could squash North Korea like a bug. America spends a lot of money on defense. We have a state-of-the-art Missile Defense Agency, or MDA, which includes the following names:
- Northrop Grumman (NYSE:NOC), the prime contractor on the MDA's Joint National Integration Center, a simulating and war gaming center that provides answers for America's missile defense capabilities.
- Boeing's (NYSE:BA) Ground-based Interceptors -- our first line of defense against missiles.
- Raytheon's (NYSE:RTN) SM-3, a defense weapon used to destroy incoming ballistic missiles.
- Lockheed Martin's (NYSE:LMT) Aegis Missile Defense System, the primary sea-based component of the missile defense system.
Because of sequestration, defense is facing significant cuts. But here are some important points to consider.
On March 1, President Obama signed across-the-board cuts into law. Somewhat shockingly, the markets, and the aforementioned defense giants in particular, responded with a yawn.
I think there are three main reasons for that type of reaction:
- America is getting used to Washington's shenanigans.
- The cuts haven't been felt yet.
- People still expect a resolution.
But here's the thing: It's almost guaranteed that a resolution will include cuts. America can't keep spending as if the bill will never come due. It's irresponsible, and it will end up hurting us more than Kim Jong-un's tantrums.
Most lawmakers know that, so if a budget resolution is ever reached, the Department of Defense will probably still face painful cuts. Nevertheless, the escalating threats coming from North Korea bring into sharp focus why a strong missile defense network is imperative, and why the MDA and its key players aren't going anywhere. Conversely, budget constraints also point to the need for smarter, modern, and more affordable defense systems. Enter the unmanned aerial vehicles, or UAVs -- otherwise known as drones.
Over the past few years, drones have become the fastest-growing segment in the Air Force. Although they are by no means inexpensive, the likes of the MQ-1 Predator and MQ-9 Reaper built by General Atomics are still cheaper than any of the manned fighters they compare with. More importantly, UAVs are part of the future of modern warfare.
Take, for example, President Obama's offer to sell South Korea four of Northrop's highly praised Global Hawks, specifically so South Korea can spy on -- er, more closely "monitor" -- North Korea's activity. Also consider that in 2012, the United States' use of drone strikes rose 72%. The reason is clear: UAVs don't risk pilot lives, they're not subject to human fatigue, they cut down on the need for boots on the ground, they allow for precision targeting, and they don't require the traditional support for combat missions. And besides the Global Hawk -- which costs more than Lockheed's F-35 -- they're cheaper overall.
Two more companies that could benefit from this push are Textron (NYSE:TXT) and AeroVironment (NASDAQ:AVAV). Although Textron isn't exactly a small defense company, it's nowhere near the size of the giants. Still, with its $8.5 billion market cap, it's highly unlikely that sequestration can take it down. And with a $2.9 billion backlog in its drone and weapons systems alone, it looks pretty stable.
AeroVironment, on the other hand, is indeed smaller, and budget cuts will have a more pronounced impact on its revenue. Tighter defense spending, coupled with a reported 34% decrease in its drone segment in its latest quarterly report, has already hammered the stock. However, if shares continue to drop, I'd consider adding some to my portfolio. The company has a good product, and it could definitely turn around, but it's still a little over what I'd like to pay.
Sequester or no, defense spending is tightening. However, there are some elements that the U.S. can't afford to cut. Missile defense is a prime example, especially with Kim Jong-un doing his little nuclear war dance. The other thing to consider is this: UAVs are the wave of the future, and I can see the U.S. and others relying on them more heavily on them down the road. Consequently, the companies with a strong position in missiles and UAVs are great for long-term investments.