When war breaks out, defense companies tend to make money. That means aerospace and defense stocks can serve as safe havens for investor cash during geopolitical unrest.
But so far, that has not been the case following Russia’s invasion of Ukraine.
Global military spending grew by 0.7% and topped $2 trillion for the first time in 2021, a new report from the Stockholm International Peace Research Institute found. That number is expected to grow significantly this year. The US fiscal 2022 omnibus spending bill included a 4.7% increase in defense spending, to $728.5 billion.
The sector is also likely to benefit from President Joe Biden’s $3.4 billion commitment to aid Ukraine in the fight against Russia.
“Most NATO member countries are now implementing or proposing increases in defense spending that will make 2% of GDP the floor for defense spending, not the goal,” wrote analysts at Bank of America (BAC).
First quarter corporate earnings, however, show that fighter aircraft and weapons-makers have actually been hurt by Russia’s invasion of Ukraine. That’s because they’ve lost one of their top customers: The Kremlin.
Although defense-sector stocks soared in February as Russia began its attacks, they’ve since settled back down. iShares U.S. Aerospace & Defense ETF (ITA), which tracks companies including Raytheon (RTN), Lockheed Martin (LMT), Boeing (BA), General Dynamics (GD) and Northrop Grumman (NOC), grew by about 10% between late February and early March. This month, it’s fallen nearly 6.5%.
Investors don’t always realize how slowly money flows from Congress to the US Treasury to contractors. It’s a process that takes time.
“Those investors expecting a quick boost in [first-quarter] earnings at the defense contractors due to the war in the Ukraine will likely be sorely surprised,” wrote Bank of America.
Raytheon Technologies lowered its revenue forecast for the year Tuesday, blaming the dip in sales on Russian sanctions. Shares of the aerospace and defense firm are down about 4.4% for the month.
Raytheon CEO Greg Hayes told investors that the revenue guidance was lowered by $750 million because the global sanctions imposed on Russia limited sales. Before sanctions were implemented, Russia accounted for about 1.5% of Raytheon’s sales, or roughly $900 million per year. The company said the sanctions caused a “relatively significant hit” on earnings.
The company still might see a bump in sales due to Ukraine-related orders, Hayes said, but not this year. Production of Raytheon’s Stinger and Javelin missiles, key weapons in the Ukrainian resistance to Russia, were stalled because of supply chain and technology issues, the CEO said. The company won’t be able to replenish the missile supply until 2023 or 2024.
Even when production ramps up, “we don’t make a huge margin on these products. This is all cost- based pricing,” Hayes told Harvard Business Review last month.
The company is also suffering from metal shortages caused by the conflict. They’re seeking titanium sponge, castings and forgings used for aircraft parts after ending relationships with their Russian supplier, Hayes said.
Supply chain issues have hurt most defense companies, said Bert Subin, vice president of equity research at Stifel Financial. Steel, aluminum, and nickel are hard to come by, and Covid lockdowns in China will likely add to the problem by delaying shipments from Shanghai, the largest seaport in the world.
Losses throughout the defense sector
Boeing also missed earnings estimates and cited similar delays in defense programs. The company’s T-7A Red Hawk program recorded its first cost overrun of $367 million. The problems were “primarily driven by ongoing supplier negotiations impacted by supply chain constraints, COVID-19 and inflationary pressures,” Boeing wrote in its earnings report.
Lockheed Martin reported a mixed first quarter. Shares fell precipitously after the F-35 maker announced an 8% annual drop in sales because of pandemic-related supply shortages. The company said that although they’re in talks with the Pentagon to raise weapons production for Ukraine, they’ve yet to increase output. Chief Financial Officer Jay Malave affirmed on the earnings call that production for Ukraine wouldn’t have any immediate impact on its financial results.
Most large military conflicts over the past two decades have led to an initial jump in defense stocks — that includes Russia’s invasion of Crimea in 2014 and the 9/11 attacks in 2001 — but those gains were all erased as initial fears of broader impacts subsided. Although defense may be a good bet for longterm investors, said Bank of America, it’s probably not going to be a winning sector for those looking for quick gains.