With the recent outbreak of the Israel-Hamas war in the Middle East, geopolitical tensions have surged - even as the ongoing Russia-Ukraine war that started in February 2022 is already straining Europe. When wars and conflicts break out, countries' defense budgets tend to increase, which is why defense stocks have all the attention now.
Even though defense stocks might have headline-driven appeal right now, it's important to concentrate on businesses that have strong fundamentals and the potential to produce steady, long-term growth. We'll talk about two of these Wall Street-recommended defense stocks here.
Kratos Defense & Security Solutions
The first name on my list is Kratos Defense & Security Solutions (KTOS), which has been a trailblazer in the defense sector with its advanced technology and solutions. It provides high-performance drones to U.S. government agencies, and its diverse operations also cover other areas such as unmanned systems, cybersecurity, satellite communications, space, and training systems.
The stock has surged an impressive 67.5% so far this year, compared to the S&P 500 Index’s ($SPX) gain of just about 14%.
In its recently reported third quarter, total revenue jumped 20% to $275 million. The company operates through two segments - Kratos Government Solutions and Unmanned Systems - both of which saw double-digit organic growth in the quarter.
While Kratos is not profitable yet, it's working to reduce its losses, as evidenced by the most recent quarter's earnings. Its recent investments and shift towards gearing up production show its efforts to drive profitability. The GAAP net loss came in at $0.01 per share, compared to a loss of $0.06 per share in the year-ago quarter.
Eric DeMarco, Kratos’ President and CEO, said in the Q3 press release, “We are now planning on certain additional investments in 2024, including in the tactical drone and satellite areas, in order to position the Company for potentially even greater growth in 2025 and beyond."
Moreover, Kratos has also been integrating artificial intelligence (AI) into the Valkyrie (its experimental stealthy unmanned combat aerial vehicle) to enable high performance. In Q3, the company completed a test for the drone at Eglin Gulf Test and Training Range.
Looking ahead, management forecasts revenue to be in the range of $237 million to $257 million. Meanwhile, analysts predict Kratos to report a profit of $0.01 in the fourth quarter on revenue of $255 million.
For the full year 2023, Kratos forecasts revenue to be in the range of $1.0 billion to $1.02 billion, which represents 11% to 13% growth over 2022. Meanwhile, analysts foresee revenue of $1.02 billion with adjusted earnings arriving at $0.35 per share. That would indicate 13% and 14% growth in revenue and earnings, respectively.
Furthermore, analysts predict 2024 sales will rise by 9% to $1.11 billion. Kratos trades at just 2 times forward sales, based on its 2024 forecasts - which seems quite cheap for a growth stock.
What Is Wall Street’s Take on Kratos Defense Stock?
Analysts have assigned a “moderate buy” rating to the stock, with an average target price of $19.10. This indicates an upside potential of roughly 10% over the next 12 months. Out of the 9 analysts covering the stock, 4 have a “strong buy” rating, 2 have a “moderate buy” rating, and 3 have a “hold” rating.
General Dynamics
Established in 1899, General Dynamics (GD) has been a stalwart in the global defense and aerospace industry. Its diverse range of offerings includes business jets and defense aircraft, shipbuilding and repair, land combat vehicles, weapons systems, and munitions. Additionally, the business offers state-of-the-art IT services and solutions, such as data analytics, cloud computing, and cybersecurity.
Despite the stock's slightly negative performance year-to-date, Wall Street remains bullish on General Dynamics’ near-term prospects, given the rising demand for defense products and services.
In GD's recent third quarter, its total revenue jumped 6% year-over-year to $10.6 billion. A record backlog of $95.6 billion propelled revenue growth. Its Marine and Combat Systems segment reported the highest growth during the quarter.
Combat revenue growth was mostly driven by “new international vehicle programs, the ramp-up of the M10 Booker, higher artillery program volume, and higher volume on Piranha and Eagle vehicles in Europe,” according to management.
Net earnings per share dipped to $3.04 from $3.26 in the year-ago quarter, but surpassed analysts’ estimates by $0.12 per share. Notably, it generated $1.1 billion in free cash flow in the quarter and had $1.3 billion in cash and cash equivalents.
Another reason to like General Dynamics is that it is a Dividend Aristocrat. The company has hiked its dividend consecutively for more than 30 years, and currently yields over 2%. Besides paying dividends and buying back its shares, GD also paid off debt of $500 million in the most recent quarter, reflecting its financial strength.
Looking ahead, CFO Jason Aiken stated in the Q3 earnings call that they expect strong orders going into Q4, further adding that “a wildcard in the quarter will be the conflict in Israel and its impact on demand, if any. “
Moreover, General Dynamics keeps securing new contracts that could boost revenue and earnings. To name a few, it has a $217 million contract for a Virginia-Class submarine, a $450 million contract with the Centers for Medicare and Medicaid Services, and a $754 million ship repair contract with NASCO. In the third quarter, its aerospace division bagged $2.9 billion in new orders.
What Is Wall Street’s Take on General Dynamics Stock?
After its Q3 earnings, analysts at Wells Fargo, Deutsche Bank, Argus, and others raised their target price for GD. Overall, the Street rates it a “strong buy.” Out of the 16 analysts covering the stock, 11 have a “strong buy” rating, 1 has a “moderate buy” rating, and 4 have a “hold” rating. The average target price for the stock is $271.07, which implies a roughly 12% upside potential over the next 12 months.
Priced at 1.43 forward sales, General Dynamics is also a reasonably valued growth stock. Analysts predict its 2024 revenue will increase by 7% to $46 billion.
Key Takeaway
With a commitment to pioneering technology and a diverse range of solutions, Kratos and General Dynamics continue to be beacons of innovation, ensuring the safety and security of nations.
As geopolitical tensions persist and the need for robust defense solutions grows, the chances for KTOS and GD to capitalize on this demand will rise, further driving their fundamentals. Therefore, just like Wall Street analysts, I remain bullish on both defense stocks now.
On the date of publication, Sushree Mohanty did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
