These Three Arms Stocks Underpin US Support For Israel

From communications kit to missile components, much of Israel's military might can be traced back to deals done with US arms businesses

Vikram Barhat 19 October, 2023 | 6:35AM
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BAE Systems Vehicle

In an era sadly marked by escalating geopolitical tensions, the global arms industry is witnessing a sharp surge in demand. The ongoing conflicts between Israel and Hamas, as well as Russia and Ukraine, have compelled nations worldwide to bolster their defence capabilities, or, at least, to say they will.

In practice, rising defence budgets have benefited arms manufacturers. Global military spending hit a record $2.24 trillion (£1.8 trillion) in 2022, up 3.7% from the previous year, per the Stockholm International Peace Research Institute. This surge, attributed to the Ukraine war – and further boosted by the ongoing Gaza conflict – has spurred demand for weapons as the US equips Israel’s Defense Forces with additional military gear.

As the primary suppliers of Israel's military arms, the following US arms companies may benefit in the longer term from the escalating demand for their products and technology amid concerns that the ongoing conflict may extend to other regions in the Middle East.

Lockheed Martin (LMT), the world's largest defence contractor, runs several businesses. The Aeronautics division, its largest, generates over two-thirds of its income from next-generation F-35 fighter jets, of which the UK is also a customer. The firm also manufacturers and sells missiles and fire control technology, as well as satellite-compatible systems.

The Wide Moat firm remains one of the largest suppliers of arms and defence systems to Israel, including F-35s, Multiple Launch Rocket System (MLRS), and other military hardware. The company claims it is "proud of the significant role it has fulfilled in the security of the State of Israel." 

"Lockheed should benefit from recent and foreseeable increases in US defense spending, driven in the short term by orders to resupply munitions to Ukraine as its forces expend them faster than they can be made," says a Morningstar equity report.

In the long run, the Pentagon is focusing on upgrading the military to deal with threats from big rivals like China and Russia. It's also managing terrorism threats in places like Iran, North Korea, and the Middle East. In the UK, defence budgets are stretched, as our recent analysis of the UK's DSEI arms exhibition showed.

"As a bet on the defence industry, Lockheed is hard to beat," asserts Morningstar equity analyst Nicolas Owens. He puts the stock’s fair value at $480. 

The arms dealer and its investors benefit from the sheer scale of its tens of billions of dollars worth of contracts that provide defined decades-long revenue and profit streams, he adds.

 

British aerospace and defense giant BAE Systems (BA) is the largest defence contractor in Europe and one of six prime contractors to the US Department of Defense (DoD). The UK's largest manufacturing firm, the company has five operating segments including electronic warfare systems, a cyber, security, and intelligence segment, as well as combat vehicles and munitions segments, among others.

"Live footage of Israel's domestically-developed short-range missile defence system referred to as the 'iron dome' demonstrates capabilities most closely associated with RTX's and BAE Systems' munitions portfolios," says a Morningstar equity report.

The defense market is experiencing a growth spurt, driven by rising global security concerns, which have been amplified by the conflict in Ukraine.

"We anticipate this growth will be uninterrupted for at least several years, considering that many countries, particularly in Europe, have underspent since the end of the Cold War," says Owens, who puts the stock’s fair value at £11.71.

Given its significant stakes in a broad array of major international defense projects, BAE Systems is strategically positioned to benefit. The contractor is well aligned with US DoD growth programmes (45% of its revenue) and stands to gain from increased US defence spending as tensions with Russia and China continue to escalate.

Further, expectation of "the European defense budget to increase by almost 35% in the next five years," will continue to drive BAE’s business across segments.

RTX (RTX) is an aerospace and defense behemoth created from the merger of United Technologies and Raytheon. Its businesses include Collins' aerospace componentry and subassemblies, Pratt & Whitney's engines, and Raytheon's missiles, sensors, and communications kit.

Raytheon supplies a range of defense hardware, including Iron Dome missiles.

RTX is a combination of "powerhouses in the commercial aerospace and defence contracting industries and is unique in its relatively even split between commercial and defense revenue," says a Morningstar equity report, adding that most other firms in the industry are heavily skewed one way or the other.

RTX's Raytheon segment is well positioned to benefit from geopolitical tensions and outright warfare which have forced many countries, including the US, to increase their defense spending.

"We assign the Raytheon segment a wide moat based on intangible assets, stemming from product complexity and a contract structure that largely grants monopolies to government suppliers, and switching costs, [mainly] due to the mission criticality of the product, long product cycles, and a lack of viable alternative suppliers once a program is in production," argues Owens, who puts the stock’s fair value at $111.

Many of RTX’s sensors are also widely used in military aircraft and ships, which have product cycles lasting decades.

This article originally appeared on our US and Canadian sister sites and has been edited and republished for UK audiences

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
BAE Systems PLC1,386.00 GBX-0.79Rating
Lockheed Martin Corp467.35 USD0.06Rating
RTX Corp106.27 USD0.82Rating

About Author

Vikram Barhat  is a Toronto-based financial writer specialising in investing, stock markets, personal finance and other areas of the financial services industry. 

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