5 Aerospace Stocks With Bullish Ratings

Early this year, U.S. Defense Secretary Robert Gates outlined plans to shift or cut Pentagon spending by $178 billion, fueling speculation about whether defense stocks would suffer. However, as a story in Saturday’s New York Times points out, "Even in an era of tighter budgets, the Pentagon is going to make sure the military industry remains profitable." Quoting under Secretary of Defense, Dr. Ashton B. Carter, "Taxpayers and shareholders in defense stocks are aligned."

With that thought in mind and furthered by our belief that 2011 will be the year of the large caps, we screened our database of 5000 stocks for defense related large cap companies with bullish Chaikin Power Gauge ratings. These five cash rich companies with good profit margins and excellent ROE are where the Pentagon is placing their bets and investors should focus here as well. All five have a low P/E ratio on projected 2011 earnings and continue to attract investor interest at current levels resulting in bullish price/volume activity.

Our research report on each of these five stocks expands on the analysis in this blog post.

Our rating is based on a 20-factor model incorporating financial metrics, earnings performance, price/volume activity and expert opinions to determine a stock’s potential over the next 3-6 months.

General Dynamics Corporation (GD): 77.45

A well-diversified company with a lot of free cash flow, consistent earnings growth, healthy profit margins and an excellent ROE, General Dynamics continues to gain analyst and investor confidence, thus leading to very bullish money flow activity.

The company posted strong 4th quarter and full year earnings for 2010 beating analyst estimates and is cautiously optimistic regarding 2011 expecting a modest 4% rise in revenue and earnings. GD has a low price/sales ratio and a low P/E ratio on 2011 earnings. Management reduced long-term debt by 23% in 2010 strengthening the balance sheet and the board authorized a stock repurchase program early this month.

The recent cutbacks announced by the defense secretary directly impacted the company since the cutback plans included scrapping the development of the expeditionary fighting vehicle the company was developing for the Marine Corps. However, CEO Jay Johnson assured investors that the company’s defense work was diversified enough to handle such adversities.

Since bottoming out in September last year, shares have rallied along with the markets to gain over 40% and are nearing their 52-week high. We blogged on GD on December 6 and again on December 20, and shares have gained over 14% and 10% respectively outperforming the major indexes during this time frame. We think that any pullbacks at these levels should provide a buying opportunity as GD continues on its long term growth path in 2011.

L-3 Communications Holdings Inc (LLL): 80.04

High profit margins and ROE, low valuation ratios and a positive business value* contribute to a very bullish financial metrics ranking for L-3 Communications.

Just last week, the company’s board authorized a 12.5% increase in its annual dividend payout to shareholders from 40 cents a share to 45 cents a share. This is the seventh consecutive annual increase in the dividend rate. For the full year 2010, the company improved its earnings by 8% on slightly higher revenue and better operational efficiencies. LLL repurchased over $800 million dollars of its common shares in 2010. The company recently raised its earnings guidance for 2011.

Bullish money flow activity, price trend ROC and volume trends contribute to a very bullish price/volume component and lead to a bullish rating. After lagging its industry and the broader markets in 2010, shares have rallied significantly this year but are still 15+% off their 52-week highs. We believe the current strength in LLL will continue and expect the stock to outperform the market over the next six months.

Lockheed Martin Corporation (LMT): 81.69

Following a strong 4th quarter, the largest U.S. defense contractor, provided 2011 guidance acknowledging the impact the defense cuts will have on its earnings, expecting revenues to grow by a modest 3%. However, with a strong balance sheet and a global presence, the company can easily weather this storm.

Management plans to buy back shares in 2011 and recently announced a 1st quarter 2011 dividend payout of 75 cents per share. A low price/sales ratio and a low P/E ratio on 2011 earnings combined with a very high ROE lead to very bullish financial metrics. Despite the recent defense budget cuts, the company is well positioned to grow in the long term as evident by the many contracts it has won just in the last couple months.

Analysts, increasingly bullish, continue to have high expectations for Lockheed and this coupled with recent insider buying activity contributes to a very bullish expert opinions rank. Strong price trends and positive volume trends further strengthen a very bullish rating.

Shares have rallied over 20% since the November lows but are still 6% below 52-week highs. We believe that pullbacks from these levels provide an opportunity to buy LMT as it benefits from the global demand for defense technology.

Northrop Grumman Corporation (NOC): 70.51

Last week, Northrop Grumman reported 4th quarter earnings of $1.27 a share handily beating analyst estimates of $1.01 per share. The company posted a year over year increase in earnings despite lower revenues reflecting an efficient operational plan by a very strong management team.

The anticipated sale or spinoff of the company’s shipbuilding business in 2011 will enable NOC to focus on its robotics, information technologies and high-end surveillance gear businesses and will impact the company this year but bodes well for the future as revenue growth was seen in most of these business lines. The company repurchased over 19 million shares in 2010 showing management’s faith in its long term prospects.

A low price/sales ratio and a strong ROE contribute to bullish financial metrics. Positive money flow activity suggests that shares are gaining momentum and along with a very bullish earnings performance metric, helps bolster a very bullish rating.

Shares are in a rally mode despite the recent negative news of Pentagon budget cuts. This should continue for the near term, and given the company’s global presence coupled with a refocus on its strengths, we believe this rally will take the stock to higher highs over the next six months.

Raytheon Co (RTN): 51.08

Raytheon’s 4th quarter 2010 earnings were up sharply, on both an adjusted and unadjusted basis compared to last year, on a very modest rise in revenue. This management strength means that if revenue increases accelerate, operational efficiencies will lead to higher profit margins and ROE.

In 2010, Raytheon repurchased 29 million shares while also signing an agreement to acquire Applied Signal Technology Inc. in the 1st quarter of 2011 to add to its Space and Airborne systems business. Management predicts revenue growth in 2011 despite the defense budget cuts which reflects the company’s international presence. Also, the budget for the Missile Defense Interceptor was increased by $1.7 billion which bodes well for Raytheon, along with LMT and NOC.

Analysts are bullish on 2011 prospects and have raised their full year earnings estimates. A low price/sales ratio and excellent ROE contribute to a very bullish financial metrics ranking. Despite a 13% rally in the last two months, the stock is still 15% off its 52-week high. We believe this puts RTN in a position to rally strongly in 2011 as it catches up with its defense industry peers.

*Business Value is the most heavily weighted factor in our 20 factor gauge rating. It measures free cash flow per share on a relative basis vs. 3000 stocks. It is similar to EV/FCF.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.