Perpetual War Is Coming, Are You Ready to Profit?

Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

1984 is famous for describing perpetual war; an un-winnable, but ever-present conflict. In the Second World War the globe saw total war throughout every continent. Nation's entire economies and societies reoriented themselves around military objectives. Now, the world is slowly entering into a new stage of less obvious, but perpetual conflict through drone warfare. A number of military contractors are setting themselves up to benefit from this new system.

Unclear Legalities are a Boom for Military Contractors 

The 2001 Authorization for Use of Military Force has been liberally interpreted and used to engage in a U.S. drone war from Pakistan to Yemen, killing thousands. Yet, the U.S. has never officially declared war against Yemen or Pakistan. Firing thousands of missiles isn't cheap. The ability of the U.S. to engage in significant armed operations in various nations without congressional approval is great news for military suppliers. The need for congressional approval would further limit the number of armed conflicts the U.S. can engage in and the need for company's goods and services.

Currently, unmanned aerial vehicles (UAVs) are just slightly less expensive than manned aircraft, due to the large number of workers required to babysit UAV systems. Second generation drones are increasing their autonomous capabilities and decreasing the number of man-hours required per hour of operation. These systems are a great fit with the U.S. military's push to decrease costs, and progressive military contractors recognize the profit opportunity.

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Boeing (NYSE: BA) sells unmanned drones in addition to their popular civilian aircraft. It developed the X-45 as a test, but in the end it didn't win the Navy's contract. Through its INSITU subsidiary it sells a number of low cost and easy to launch surveillance drones. These little drones are great export products as UAVs are the latest must-have toys for any respectable military. 

Boeing is a good company to watch as it gains a large portion from its revenue from civilian aviation contracts. These contracts help to limit the impact of short term Pentagon cuts. Also, its civilian operations give Boeing a large amount of experience in aircraft production that can be transplanted into its future UAV products. Boeing boosts a return on investment (ROI) of 26.3% and a gross margin of 18.2%. Its total debt to equity ratio of 1.77 is rather high, but Boeing is stable multinational with a large order book. 

Northrop Grumman (NYSE: NOC) produces the popular RQ-4 Global Hawk reconnaissance drone and is developing the MQ-4C variant for the U.S. Navy. These high flying surveillance aircraft are more flexible than satellites, yet don't require the U-2's complicated oxygen systems. Northrop Grumman won the important X-47 contract to develop a carrier drone. The development of this drone is an important landmark, because it shows that drone technology is maturing to the point where it can deal with challenging carrier takeoffs and landings. 

The company's total debt to equity ratio of 0.42 is significantly less than Boeing's, but Northrop Grumman is a much smaller company and very dependent on the U.S. government. In the next couple years, its ROI of 14.6% and profit margin of 7.8% could take a hit as the Pentagon cuts back on a number of programs. Regardless, Northrop Grumman's presence in important programs like the X-47 shows that the company is well-suited to take advantage of the coming drone wars. 

General Dynamics (NYSE: GD) is working on a number of drone programs. It is trying to help the Pentagon save on its labor costs. Through the unmanned autonomous collaborative operations program, the company is trying to make a system where a single operator can control multiple unmanned systems. This system would decrease the number of men required to operate a drone fleet and help make the U.S. military more efficient.

In the long run, General Dynamics is good contractor to watch. Its debt load is manageable with a total debt to equity ratio of 0.34. Its short run situation looks a little more challenging. Its earnings before interest and taxes (EBIT) margin of 2.2% and profit margin of -1.0% are suffering and government cuts will not help the situation. 

Conclusion

The U.S. has set a new precedent by engaging in a massive worldwide drone war with only vague congressional approval. The legalities of the situation are a mess, but it is clear that the world is moving toward new system of perpetual war where the frequent shooting down enemy drones is considered a somewhat ordinary occurrence. 

Northrop Grumman is one of the best companies to watch as its X-47 drone will provide a major advancement for the U.S. Navy. Boeing and General Dynamics don't get as much press coverage, but they deserve a place on your watch list. As the Pentagon announces new to programs to try and develop more cost effective and autonomous UAVs, these companies will try and gain a piece of the pie. 

Boeing operates as a major player in a multi-trillion-dollar market in which the opportunities and responsibilities are absolutely massive. However, emerging competitors and the company's execution problems have investors wondering whether Boeing will live up to its shareholder responsibilities. In our premium research report on the company, two of The Motley Fool's best minds on industrials have collaborated to provide investors with the key, must-know issues surrounding Boeing. They'll be updating the report as key news hits, so don't miss out — simply click here now to claim your copy today.


Joshua Bondy has no position in any stocks mentioned. The Motley Fool owns shares of General Dynamics and Northrop Grumman. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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