Bring Home the Troops – and Send out the Drones! (RGR)

Ladies and gentlemen, we’ve touted the war stocks in this space for some time now as part of our Four G’s investment strategy (GUNS, GOLD, GAS AND GRUB), and we’ve also promoted the small arms market as a reliable place to make money.

But more than that, we put our money where our big mouth is many’a’time, using Sturm Ruger (NYSE: RGR) and Smith & Wesson (NASDAQ: SWHC), among others, to ride the pistol-packing profit train to a pretty peso.

Here, by the way, is a look at those two much heralded gun manufacturers for the last few years…

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It might not be until we have a more settled political environment that gun sales peak and begin to turn over. Until then…

Bombs Away!

It’s now to the big wheels and wings of the weapons industry that we turn our attention, to reiterate and update some sentiments we first offered on the sector back in mid-November of last year in a letter called Oh, the Outrage!

There, we summed up our feelings on the matter thus…

The world is no less peaceful today than it was five, ten or even thirty years ago. In fact, the number of open conflicts has grown since the Cold War ended… And we see it in the defense budget. Our call is like this – we see open hostilities ramping up in the Far East, Middle East and Africa in the very near term. And we also believe the prospects for both civil and cross-border strife is growing in… Central and South America…. the upshot for investors is that the American war machine will be working overtime in the next few years, producing and selling armaments in vast quantities to an ever growing roster of nations and guerrilla groups the world over.

Our speculations have been realized most strikingly of late in the Ukraine and Venezuela, where civil conflicts are now threatening to spill over national borders. Also, in the ongoing strife in Syria, Lybia and Egypt, South Sudan and Nigeria, as well as the region surrounding the Congo, where intermittent bloody battles have again become the norm.

And the question on every young investor’s mind is how will these new conflicts affect American arms suppliers – particularly in light of planned, deep budget cuts to the armed forces in years to come?

Our thoughts back in November were not founded on any knowledge of the upcoming cuts to the military announced recently by Secretary Hagel. Under his proposal, the military would shrink from its current 520,000 soldiers down to 420,000 by 2016, making for the smallest American fighting force since prior to WWII.

And while that has alarmed some, we don’t believe it should cast fear into the fighting heart of the dedicated aerospace/defence investor.

On the contrary, it’s more likely that a reduced soldier base would place more emphasis on remote fighting capabilities that rely on drone technologies and specialty fighting units that require more advanced armaments and technology and would therefore boost spending in those areas.

It’s clear that the market has yet to take issue with the Defense Secretary’s numbers. Below is a paste-up of one year’s trade in a market cap weighted index of U.S. listed defense contractors against the S&P 500 –

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As you can see, the broad market returned a solid 22% over the last twelve months, versus a gigantic 58% for the big guns.

And we expect the trend to continue.

So what do we buy?

The charts for most of the big contractors look strong, but there are a few that we believe hold the most promise. Please consider them all.

First, General Dynamics (NYSE:GD) –

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Technically, RSI and MACD are above their waterlines, and although we had a MACD crossover late last week, it still has enough altitude to deem it benign for the moment.

All moving averages are unfurled and trending higher with price above them all.

Volume is picking up, and wars abound.

In short, there’s very little not to like here.

Since we last wrote about the defense stocks, GD shares have added 25% on the back of a strong order book and a leading edge in the drone business. We highlighted them back in November for that reason, and they bear continued observation for the immediate future as well.

The most recent pullback, from $113 to $108, we believe, offers a neat entry point for investors desirous of a long term play with lots of potential, or for those who’re thinking of a leveraged shorter term bet using six or eight month CALLs. Either way, the time is ripe. We note, too that the stock still offers a 2.29% annual dividend – even after all the gains it’s racked up in this bull market.

Two other potentials worth looking at are Raytheon (NYSE:RTN).and Lockheed Martin (NYSE:LMT), both space-age enablers of the kill machine.

Many happy returns,

Matt McAbby
Senior Analyst
Normandy Research

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