Why Military Spending Won't Die

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

In mid-January, the U.S Navy's Guardian minesweeper ship ran into a coral reef off of the coast of the Philippines. Luckily, no one was hurt. However, the event is a major embarrassment far beyond the ego bruise you might feel if you tripped in public. This event brings into question the ability of the United States to project its power overseas. It also shows why investing in the industrial military complex will never go out of style.

Crash

On Jan. 17, the Guardian was moving to Indonesia after a stopover in Subic Bay. For reasons not yet known, it sailed into a protected region of water where no boats were supposed to stray. The ship eventually found itself stuck on the Tubbataha Reef. Luckily no humans were injured, however the reef may not get off as lightly. That said, the ship's fuel was safely removed, averting at least one potential environmental disaster.

The are a lot of upset people. Clearly environmentalists are up in arms that a U.S. military ship has destroyed a portion of a protected coral reef. The Philippines' president, meanwhile, has called for answers and said fines will be imposed. And, in order to minimize any further damage, the ship will be dismantled. All of this seems fairly appropriate.

Exposure

The bigger issues here are the most concerning. For example, there are questions about the crash being caused by faulty navigation systems. There is the loss of a mine sweeper that could be vital if tensions with Iran were to flare, or, even less desirable, if China were to become a military issue. Then there is the disgrace involved in the fact that the powerful U.S. Navy can't navigate its way safely around the world to the far off lands in which we, as a nation, need to be engaged. Some of our allies may be chuckling, but it could be a nervous laugh.

These are all notable reasons why military spending isn't going to go away anytime soon and, in fact, may have more legs than people think. For example, the ship that crashed was over two decades old. The government has been working on a new set of ships, called the Littoral Combat Ship, that, on paper, are truly impressive and versatile ships. However, getting them made has been harder and more expensive than originally planned. Until the Littoral Combat Ship program gets straightened out, we've got to rely on an aged fleet.

While some will explain that the United States has the largest and most advanced military fleet in the world, and that other nations are years away from competing, that doesn't mean we can sit on our laurels. Great Britain also once had the greatest military fleet. Now it doesn't. Our nation's leaders often don't act until they have to, as the constant last-second debt limit talks clearly demonstrate. So there may be more such embarrassments in the near future, but, eventually, military spending will be supported by enough politicians that it will get a big boost.

In the meantime, spending will likely be trimmed, but not to the depths that some may fear. That makes some key defense contractors worth a look. Some to consider are:

General Dynamics (NYSE: GD)

General Dynamics is a key supplier to the U.S. Navy, however, it has notable operations in the combat systems, information system, and aerospace arenas. Its non-military operations largely consist of its Gulfstream jet business. The company is financially strong and well positioned in its businesses. It recently reported a large write off, which caused the company to fall into the red for 2012. Taking out the write off, however, its earnings only fell slightly.

The company's Aerospace division was the star performer in 2012, with sales declines at its other three segments. The Marine Systems division saw only a slight revenue decline. Boats take a long time to build and there are only just so many companies and facilitates capable of constructing them, so this business can be relatively stable over time. The company is currently building a number of ships for the Navy that should keep the division busy for a long time.

With a dividend yield around 3% and the continued overhang of military spending cuts, this is an interesting way to invest in America's Navy capabilities. It also has the counterweight of its non-military revenues to help smooth performance over time.

Lockheed Martin (NYSE: LMT)

Lockheed Martin is by far the largest military contractor. It also has a dividend yield in the 5% range and a history of annual dividend increases. So, for investors seeking income and broad exposure to the defense industry, Lockheed is a great selection. With its massive scale and reach, Lockheed Martin will definitely feel the pinch of any cuts, but it will survive any cuts that do take place.

Longer term, the company is probably one of the best positioned defense companies around. Its fingers extend into virtually every aspect of the industry from space exploration to military services, including expanding operations in the technology space. One of its interesting specialties is in cyber warfare, where it offers secure wireless testing services and a cyber forensics lab. That makes this high-yielding stock an interesting option for those looking to get in on the cutting edge of the military's needs.

Northrop Grumman (NYSE: NOC)

Northrop Grumman also has its eyes set on cyber issues, placing cybersecurity second on its impressive list of capabilities. The list starts with unmanned drones, which shows that it is at the forefront of another particularly hot area right now. These two areas should help soften the blow of any budget cuts, since they aren't as likely to be trimmed as we move toward less human-intensive capabilities. Like the other two companies noted above, Northrop has exposure to multiple aspects of military spending, with important positions in some key spending programs. It, too, will survive any spending cuts. With a dividend yield recently above 3%, income investors would do well to examine this military supplier.

Raytheon (NYSE: RTN)

Raytheon, another of the big boys in the military/industrial complex, has an equally diverse portfolio of products and services. Like Northrop, Raytheon lists cybersecurity second on its list of capabilities. The interesting thing, however, is that electronic warfare is also listed (third). While this division is geared toward helping the military better manage war time actions, all of this division's systems make use of connectivity. With accusations of China attacking The New York Times, protecting these systems at the military level seems nothing short of vital to America's security.

A yield of over 3.5% and a company focus around technology makes Raytheon an interesting option. Note, too, that its Missile Systems division is an important strength. This group allows for troops to stay out of harms way and can quickly clear a battlefield to facilitate easier troop movement. As we move toward less feet on the ground, missiles will be increasingly important.

Unsavory but Necessary

Some people don't like to invest in companies that serve the military. While that's understandable, a strong military is an absolute necessity. Right now, some of our leaders have been pushing back that notion. The ship wreck in the Philippines is just a small reminder that we can't. Eventually more politicians will come to see this. In the meantime, it may be an excellent time to add some defense contractors to your portfolio.

Yours,
Reuben Gregg Brewer 


Reuben Gregg Brewer has no position in any stocks mentioned. The Motley Fool owns shares of General Dynamics, Lockheed Martin, Northrop Grumman, and Raytheon Company. 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.

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