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Defense Stocks Still Posting Solid Gains


Extending an extraordinary run-up that began in earnest after Sept.11, defense-related stocks surged again Wednesday as investors continued to embrace the prospect of sharply higher Pentagon spending.

Even though some analysts are warning that the sector is just about played out and shares are fully valued for now, momentum continues to build with new buy recommendations.

In a run-up not seen since the hefty defense spending days of the Reagan administration in the early 1980s, shares of some major defense contractors have jumped by more than 60% since the terrorist attacks, with many of them reaching 52-week highs during recent weeks.

Lockheed Martin Corp. rose $1.43 on Wednesday to close at $61.03, the highest in more than three years and more than triple the value of its shares in March 2000.

A Lockheed investor who purchased 100 shares for $1,700 two years ago had a paper profit of $4,400 on Wednesday.

"Defense is a magic word again," said Paul H. Nisbet, a longtime defense analyst with JSA Research Inc. "People are jumping in."

Wednesday's surge in defense stocks was partly attributed to an announcement that investment firm UBS Warburg is beginning coverage of the industry and is recommending investors buy stocks of several defense firms, including General Dynamics Corp., Raytheon Co. and Lockheed.

Coupled with a broader market gain, the entire defense sector appeared to benefit.

General Dynamics climbed $1.36 to $96.07, Raytheon gained 97 cents to $39.67, and Northrop Grumman Corp. rose $2.90 to $117.65.

"We expect the group to outperform the general market in the current environment of higher defense budgets, economic uncertainty and war," wrote UBS analyst David Strauss, who said Lockheed stock could rise to $68, General Dynamics to $108 and Raytheon to $50.

But some longtime defense analysts weren't as bullish, cautioning investors that the fundamentals of the industry have not changed since the Bush administration proposed a 14% increase in defense spending, the largest such jump in 20 years.

Moreover, some analysts have recently switched their recommendations to "hold," believing defense stocks have climbed as high as they can go for now.

"We continue to believe that some analysts and investors are using U.S. defense budget growth rates as a proxy for defense company growth rates," Byron K. Callan, a Merrill Lynch Co. analyst said in a report Wednesday to investors.

"This is flawed, in our view, because most major defense/aerospace companies derive no more than 60% to 70% of their sales directly and indirectly from the Department of Defense," Callan said.

"They are little bit rich in our perspective," said Todd B. Ernst, a Prudential Securities Inc. analyst, who has a "hold" recommendation for most of the major defense stocks.

Still, Wednesday's surge seemed to signal that investors weren't going to stop flocking to defense stocks any time soon, particularly for those that appear better positioned for the kind of defense spending that analysts are expecting.

An index of 16 major defense shares gained 2.6% on Wednesday.

The index, which includes Boeing Co., General Dynamics, Lockheed Martin and Northrop Grumman, has surged more than 30% since Oct. 1.

But the biggest beneficiaries have been companies such as L-3 Communications Holdings Inc. that primarily are focused on making defense communications and electronic devices.

L-3 Communications climbed $3.28 to $123.81, a record high, on some optimistic comments from an analyst at CIBC World Markets. L-3 is up more than 45% since Sept. 11.

"As we go into the procurement up cycle, there are several companies that are better positioned than others," said CIBC's Stephen J. Murphy, who has a "buy" recommendation for L-3.

"We think there is going to be accelerating growth, and that's getting reflected in the stock prices of certain companies."

The run-up also has prompted a few mid-size defense companies to go public, including Integrated Defense Technologies Inc.

The Huntsville, Ala.-based company began trading in February at $25 and closed Wednesday at $30.90, up 70 cents.



Rally in Defense Shares

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