Defence Industry

The defence industry covers everything from land, sea and air capabilities to electronics and cyber security effectively aiming to provide the technology that protects nations all over the world.

The largest defence companies in the world are Lockheed Martin, Raytheon Technologies, and Boeing all of which are based in the US.

The industry is highly concentrated and dominated by a small number of large firms that have the ability to influence the prices of products by a large extent. The product line of the aerospace and defence industry is broad since its primary products and flight vehicles require millions of individual parts. Additionally, the industry requires support systems that aid in the operation and maintenance of these vehicles.

The main weapon that aerospace and defence firms have to identify business opportunities and obtain a competitive advantage is, competitive intelligence. These companies must be well informed on the demands in the industry, be forward looking and aware of their competitions position in the market in order to improve organizational performance to increase market share. Competitive intelligence enables these companies to foster a culture of innovation that allows employees to implement change that drives the business forward be more efficient when entering new markets and reduce uncertainties about future trends.

Currently 7 European nations have increased defence budgets due to the raging war in Ukraine namely, Germany , Belgium, Romania, Italy, Poland, Norway, and Sweden.  Additionally, the UK is expected to announce an increase in defence spending at the next NATO summit on the 28th of June 2022. Boris Johnson has stated his commitment to modernising the UK’s armed forces with more AI, cyber space, and drones. Conversely decisions were also made earlier in the year to cut troops tanks and other kit, but this might all be set to change at the next NATO summit.

Lockheed Martin Corp.

The biggest defence contractor in the world Lockheed Martin with yearly revenue at more than $60 billion and with 96% of this revenue being pertinent to the defence industry very few companies come close worldwide.   

In recent news, three contractors received 90-day, $2 million contracts to begin work on the Stand-in Attack Weapon, or SiAW, one of the Air Force’s next generation of air-to-ground munitions. Lockheed Martin, L3Harris, and Northrop Grumman got contracts for the work out of a five-competitor field that also included Boeing and Raytheon Technologies. It was not immediately apparent whether the three companies will do competitive or complementary work under the contracts, which were awarded May 25. The five contenders were deemed the only ones qualified to do the work according to an Air Force statement from May 2021.  Lockheed Martin said its contract is to perform integration work for SiAW and that it will produce hardware over the next five years, which the Air Force will then test and evaluate for possible production.

Lockheed Martin receives the most funding from the US federal government. In a 2017 study it was found that 94% of Lockheeds $53.8 Billion revenue came from the federal government amounting to %50.7 billion. This is more than double the amount that Boeing won in contracts at a measly $23.4 billion. Recently, net sales from the US has dropped and now stands at $42,42 in 2021 this is only 62.3% of total revenue which stood at $67.044 billion in 2021. This is a positive change as Lockheed proceeds to be less dependent on a single government for contracts all the while growing at 9.6% over the past five years.

BAE Systems

BAE Systems designs and manufactures fighter jets, artillery systems, electronic equipment, and surface combat vehicles and is based in the UK. It’s the 7th biggest defence contractor in the world (the biggest ex US & China) with revenue of $23.5 billion in 2021 almost a third of Lockheed’s.

BAE Systems was awarded more in U.S. government contracts in 2017 than any other company based in a foreign country. The U.K.-based company made $5.3 billion in 2017 in U.S. taxpayer dollars. Additionally, nearly a third of BAE’s 83,200 employees are based in the United States.

The revenue growth has not been impressive at 2.4% over the past five years and has fluctuated quite a bit as is evident in the table below:

Although revenue growth has been volatile over the past 5 years it is expected to increase going forward as the UK and many European nations are expected to increase defence spending as mentioned earlier. This positive tail wind will most likely continue for the foreseeable future as tensions in Ukraine do not seem to be waning.

Northrop Grumman

A competitor of Lockheed Martin that receives a sizable portion of its profits from the US federal government. And is seen as indispensable to American military might as the company manufactures and services the iconic B-2 Spirit Stealth Bomber, which the U.S. military has deployed in Iraq, Afghanistan, and most recently in Libya. Adjusted for inflation, a single B-2 bomber costs over $2 billion, and the U.S. Air Force currently has 20 in operation are expected to be used and maintained until 2032.

In 2017 Northrop was the fifth biggest receiver of money from the Us Government and has showed impressive revenue growth over the past 5 years at %11.3.

Currently the most anticipated defensive wonder currently under production by Northrop is the new B-21 Raider despite it being quite smaller than the B-2 t will be more advanced being at least 2 generations ahead of the older B-2s. The first flight for the B-21s has been pushed from 2021 initially to 2023 but surprisingly the development has stayed within budget. The US Air Force expects to spend $20 billion through fiscal year 2027, although no indication has been given on the amount of planes that are expected to be delivered. This is a sizeable contract given that revenue for the entire firm was at $35.66 billion in 2021.

Thales

Thales Group is a French multinational company that designs and builds electrical systems and provides services for the aerospace, defence, transportation and security markets. It is the 16th biggest defence contractor in the world with total revenue in 2021 at $19.39 billion only 48% of this pertains to defence. A large part of their business is avionics which is technology used by airports airlines pilots and crews to make flying more efficient and safer. Their systems are used worldwide even in South Africa.

 Rheinmetall

A German automotive and arms manufacturer that was founded in 1889. Few defence firms or any firm for that matter boasts a history that exceeds 100 years. Despite a long history the firm is only ranked 29th in the world for revenue in the defence industry. Their revenue in 2021 boasted $6.7 billion with 63% of this revenue coming from defence contracts an 8% change from 2020. Despite this increase their five- and ten-year revenue growth rates are -0,9% and 1,5% respectively.

Conclusion:

Overall Lockheed is the better firm.  Although when financials are looked at exclusively Northrop appears to be the better performing US firm. With better valuation ratios, margins, and liquidity. Lockheed also has very strong financials with ROE and ROIC being higher as well as having the better solvency ratios. An important point to also consider is the sheer size difference between the two firms with Lockheed’s defence revenue at double Northrop’s and based off the past Lockheed has successfully acquired more contracts from the US government. Additionally, this funding has become a smaller percentage over the years all the while total revenue has continued to grow, showing the decreasing reliance of the firm on the US government to support revenue growth.

Given the current political turmoil in the world we can expect the US to continue to grow their defence budget into the foreseeable future and with Lockheed as the primary option for most of its contracts more relative growth can surely be expected. Despite a high P/E ratio for Lockheed of 18.52 its still ranked better than 67% of the industry with the industry’s P/E ratio currently at 17.67. Therefore, I conclude that Lockheed is undervalued and a BUY.

The Europeans firms are undoubtedly smaller than the US firms, this is mainly due to the huge budget that the US has for defence as well as the smaller number of competitors that are present in the US markets that suck up most of this funding. US funding though does make its way overseas with BAE industries receiving the most money from the US government outside the US this was at about 20% of BAE’s revenue in 2017. Additionally, a third of their workforce is based in the US.  If the BAE was to be used for diversification purposes away from sole US exposure, it’s important to consider how much of BAE is indeed “ex US”. Despite the high US reliance BAE Systems is a good diversifier.

BAE Systems has strong financials relative to the other European firms.  Low price multiples, good profitability as well as satisfactory liquidity and solvency. Its important to note that the proposed increase in UK defence spending will be a tail wind for BAEs growth going forward. Their P/E ratio is 14,53 which is 75,71% better than the industry average. Therefore, I conclude that BAE is undervalued and a BUY.

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