US defence firms should generally benefit from the tough line being taken by the Bush administration...
US defence firms should generally benefit from the tough line being taken by the Bush administration on terrorism in the aftermath of last month's attacks on New York and Washington.
The mood in Washington is one of bipartisanship and determination, with the result that there has been little dissent over the administration's plans to increase the defence budget dramatically.
If there were debates prior to 11 September over where to spend money and concerns about spending the budget surplus, they have now gone out of the window, believes Harald Hendrikse, a defence analyst at Credit Suisse First Boston.
'The 2002 defence budget has passed untouched and saw an $18.4bn increase from the earlier request,' he says. 'There is talk of taking defence spending up to $400-$500bn from the current levels of $330bn.'
Although all defence firms should benefit from this kind of increase in the nations defence budget, Hendrikse thinks the major winners will once again be the electronic systems providers. US companies will be primary beneficiaries of spending, although UK and European companies with significant US sales may also do well. 'Companies to watch include Raytheon (Strong Buy), Lockheed Martin (Buy) and BAE Systems (Strong Buy),' he says.
Although some commentary has indicated that the increase in spending will be only for intelligence gathering and counter-terrorism, Hendrikse feels these comments completely miss the point.
'We believe the spending will be broadly-based because the feeling is that every contingency must be covered,' he says. 'Someone just committed the unthinkable ' a major attack on American soil, what other unthinkable acts are possible? The US is in the mood to prepare against all possibilities.'
On the other hand, Clerical Medical's US fund manager James McLellan thinks the US defence sector now looks fully valued.
'Interest in the sector had been strong anyway prior to 11 September, with investors attracted by resilient earnings characteristics,' he says. 'Following the election of president Bush, a lot of commentators also thought we would see a reverse or at least a halt to the reductions in the defence budget, which had come down throughout the 1990s.
'There was an emotional reaction immediately after the terrorist attacks that led people to invest heavily in defence.
Defensive pure plays such as General Dynamics, Raytheon and Lockheed Martin rocketed 15%-20% when trading restarted, and this was in a market that was 10%-15% lower than it was before 11 September,' he adds. Clerical Medical took the opportunity to lighten its holdings in the sector at this point, he says, as he did not feel that the fundamentals had changed enough to merit that kind of rise in valuation. The kind of conflict in which the US is likely to engage, he feels, is unlikely to result in a massive surge of demand for the kind of heavy attack weaponry, helicopters, planes, tanks that these firms provide.
In any event, this kind of spending programme would take two to three years before delivery would be feasible, he argues, and this is too long a time frame for short-term investors.
Opportunities in electronics sector.
US defence spending could jump by $170bn.
Little dissent over military spending plans.
Defence stocks now look fully valued.
No significant rise in heavy attack equipment.
Long time frame for spending programme.
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