Top military contractors—with their modest valuations and likelihood of better-than-expected growth—are excellent choices as low-risk market hedges, says Stephen Leeb, editor of The Complete Investor.
Raytheon (RTN), which remains our favorite defense play, fits that bill. The company stands out from other major defense contractors for several reasons.
Its revenues are almost evenly split among four segments: space systems, missile systems, information systems, and integrated defense systems. Thus, as the most diversified of the major contractors, Raytheon is well-protected if a particular program is singled-out for cutting.
More importantly, virtually all the company's divisions require high-level information and electronic capabilities, giving Raytheon a leg-up in today's world of electronic warfare.
The company's stakes in cyber-security and warfare, secure and wide bandwidth communication systems, and surveillance, are far more extensive than those of its competitors.
Through its space division, the company provides a wide variety of unmanned imaging and targeting systems, for both offensive, and defensive purposes. These programs, not only are the least likely to suffer cuts, they could gain additional funding in coming years.
Raytheon also gets high marks for having the largest proportion of foreign customers; foreign business is likely to grow even if, contrary to our expectations, US defense spending suffers overall cuts.
Currently, Wall Street expects Raytheon's earnings to grow in the mid to high single digits. We think the low double digits is more likely, which suggests a rising P/E.
But whatever its growth rate, this critical franchise, whose projected 2014 free cash flow yield is above 8%, is a fundamental powerhouse.
In the past decade, the company has repurchased nearly 40% of its shares, and over the past five years, it has been aggressively raising its dividend. With a current yield of 2.6% and a superb balance sheet, this is a compelling total return hedge.
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