Is This A New Cold War In The Making?

Earlier this month, Russian Prime Minister Dmitry Medvedev said his country was in a new Cold War with the United States and its allies in a speech at the Munich Security Conference. Tensions have been building since the beginning of Syrian civil war in 2011 but came to a boil when Russia supported Ukrainian separatists in 2014.

Conflict in hot spots around the world have meant a resurgence of U.S. military involvement and even the Obama Administration is talking about an increased military role around the globe. In the five years through 2015, President Obama has overseen a nearly 20% reduction in the defense budget — but escalating tensions look to ignite another era of military build-up. 

#-ad_banner-#Is the United States entering another arms race? Are you ready for the windfall for companies in the Aerospace & Defense industry?

Global Hot Spots Mean Military Spending Is Heating Up
PM Medvedev’s comments stirred memories of the arms race as it and the United States spar over joint-cooperation to end the five-year Syrian conflict. Russia has blamed the United States and NATO for fueling regional conflicts while the United States and allies contend that Russia is focusing its bombing runs on the groups (supported by the U.S.) that are opposed to Syrian President Bashar al-Assad rather than Russia’s stated target, troops supporting the so-called Islamic State (IS) group.

President Obama has already signaled a proposal to quadruple military spending for NATO in Europe as a counter to Russia. The proposal calls for continuous United States armored brigade rotations through stations in central and eastern Europe along with an increase in NATO military exercises in the region. More than the increase to $3.4 billion in U.S. spending on NATO, the proposal signals a new willingness by the administration to flex its military muscle against an old rival.

Apart from the potential for a military build-up in a new cold war with Russia, the United States is also facing hotspots elsewhere against the IS group and tensions with China in the South China Sea. 

China has claimed more than 80% of the South China Sea, leading to conflict with other claimants in the region including Vietnam and the Philippines. The area is used for international shipping worth more than $5 trillion annually and challenges to China’s claims have started coming more frequently. The United States sent a warship to the area in January and Vice Admiral Joseph Aucoin of the 7th Fleet will be moving his command ship, the USS Blue Ridge, there later this summer.

General Joseph Dunford, Chairman of the Joint Chiefs of Staff, told reporters publicly late last month that he wants to use direct military action to check IS group movements in Libya. The United States is already conducting airstrikes against the IS group in Syria and Iraq and will likely be expanding its role over the coming months.

Who Wins In The New Era Of Military Spending?
The Department of Defense released its 2017 budget request earlier this month, asking for $582.7 billion including the base budget and overseas contingency operations. This would represent a 1.7% increase over the 2016 budget and could mark a return to growth for defense spending. The defense budget fell 19% from a peak of $691 billion in 2010 to $560 billion in 2015.

Northrop Grumman (NYSE: NOC) got its proposal for a long-range bomber program fully funded in the DoD budget request. The General Accountability Office (GAO) recently rejected a protest to the program by rival Boeing which could be a catalyst for investor interest in Northrop. The Air Force has allotted $12.1 billion to the program over the next five years. Northrop is one of the purest plays on increased military spending with the U.S. government accounting for 90% of the company’s sales. Shares trade for 17.4 times trailing earnings which are expected 14.6% higher through 2017.

Boeing (NYSE: BA) did well in the budget request and may benefit from delays on the F-35 program which will affect Lockheed Martin (NYSE: LMT). The company provides support for older jets like the F-18 which would be phased out by the newer F-35 fighters. Boeing got its tanker program fully funded by the Air Force as well. Shares provide some diversification on the commercial aircraft segment and trade for 14.1 times trailing earnings. Defense spending, representing 30% of sales, could provide strong upside to the shares while a backlog of 5,800 commercial aircraft orders provides stability to sales.

Raytheon (NYSE: RTN) could benefit on its exposure to munitions and missiles which is proposed to grow 3% in the 2017 budget. The firm books 30% of its sales internationally, helping to diversify revenue during periods of slower growth in U.S. defense spending. Shares trade for 17.8 times trailing earnings which are expected to jump 17% over the two years through 2017. Ratheon acquired cybersecurity firm Websense last year, expanding its role into the faster-growing information security space and could be a catalyst for faster earnings growth.

Risks To Consider: The coming presidential election in November could mean volatility for the defense contractors but even the democrats look to be backing higher spending.

Action To Take: Position for a rebound as the United States breaks its multi-year decline in defense spending and tensions flare up with an old rival.

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