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Research Market strategy
by Swissquote Analysts
Live Analysis

Strong defense sector as backlogs stay heavy

1

Driven by strong defense spending and production, the defense sector should remain solid in 2019. Rising demand should therefore prompt higher capital spending and accelerating cashflows, allowing shareholders to benefit from share repurchases in 2019. The rise in geopolitical tensions remains a key driver that induces larger demand across the globe. For instance, FY 2019 defense budget from the US is expected to reach $686 billion (+7%) while Singapore authorities will be spending along $17 billion, or 30% of total budget in the industry, suggesting significant growth momentum globally.

Aside of conventional defense spending in military equipment and aerospace, nations have to adapt by investing into digitization and cybersecurity solutions in order to integrate digital threats, a positive trend for the near term. In this regard, Leidos Hopldings, an engineering technology company active in defense, civil and health segments provided conclusive results for FY 2018, with Q4 and annual revenues of $2.52 billion (+5.20%) and $10.19 billion (+0.20%), above its forward guidance of $10.10 billion while non-GAAP diluted EPS remains in the upper bound of the $4.15 – 4.50 estimated range. Interestingly, the company has been prioritizing its customers by returning 88% of free cash flow to shareholders, or 6.5% of its market cap ($417 million share repurchases and $198 million dividends), a trend that should generalize among defense providers, with stock repurchases ranging near 4% - 6% in the sector.

Looking forward, growth of the defense industry primarily relies on spending from the US. Yet, contribution from NATO countries, which are expecting to accelerate investments after pledging a rise up to 2% of GDP by 2024 as well as India, China and Japan should lead companies active in the sector to sustainable growth in the coming years.

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