US Defense: Valuations are back to normal, although catalysts remain elusive
The recent sector pullback reflects a rotation in positioning rather than a deterioration in fundamentals, according to Bernstein analysts. Despite a favorable budgetary outlook, they see no short-term upside driver ahead of the November mid-terms.
The US defense sector is returning to historical valuation levels following a sharp decline in share prices since the onset of the conflict with Iran. Bernstein says that the previous correction was primarily driven by investors rotating into higher-growth sectors, while fundamentals remain robust. Sector valuations have reverted to approximately 87% of the S&P 500, compared to a previous premium of around 15%.
The broker still anticipates an increase in US military spending, even if the Trump administration's proposed 2027 budget of $1.45 trillion is unlikely to be adopted in its current form. Space, missiles, missile defense, autonomous systems and counter-drone technology remain its preferred investment themes.
However, Bernstein believes that no major catalyst is expected to support the sector before the November mid-term elections.
In this context, L3Harris remains its top pick with an "outperform" rating and a target price of $405. Other major players are all rated "market perform": Lockheed Martin ($614), Northrop Grumman ($660), RTX ($208), General Dynamics ($398), and Huntington Ingalls Industries ($387).
L3Harris Technologies, Inc. specializes in the design, manufacturing and marketing of information and communication equipment for the defense, government agency, and commercial structure markets. Net sales break down by family of products as follows:
- integrated mission systems (31.4%): intelligence, surveillance and reconnaissance systems, communication systems, electrical and electronic systems for marine platforms, advanced electro-optical and infrared solutions, etc.;
- space and airborne systems (30%): payload systems, sensors, complete mission solutions, confidential intelligence systems, cyber defense solutions, electronic warfare systems, etc.;
- communication systems (25.7%): tactical communication systems, broadband communications, integrated visual communications solutions, etc.;
- propulsion, power generation and defence systems (12.9%).
Net sales break down by source of income between sales of products (70.8%) and services (29.2%).
The United States account for 77.2% of net sales.
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