January 31, 2017 / 11:42 PM / 2 years ago

U.S. defense shares shrug off Trump criticism, set for further gains

NEW YORK/WASHINGTON (Reuters) - U.S. defense company shares have largely shrugged off President Donald Trump’s criticisms over costs and may be poised to fly higher even with prices at lofty levels.

A RAF Lockheed Martin F-35B fighter jet taxis along a runway after landing at the Royal International Air Tattoo at Fairford, Britain July 8, 2016. REUTERS/Peter Nicholls/File Photo

Promises by Trump to expand the U.S. military give many investors and analysts confidence the defense industry will grow strongly in coming years.

“There’s a multi-year upturn in play here. If you believe we’re in the first inning of a multi-year up cycle, the valuations can stay extended for a longer period of time,” said Peter Arment, an aerospace and defense analyst at Robert W. Baird & Co.

Bank of America-Merrill Lynch analyst Ronald Epstein in his 2017 defense industry outlook said the up cycle started before the election, but the Republican sweep in Congress could mean even more robust growth in defense than previously expected.

Defense shares shot up just after the Nov. 8 election but have experienced volatility as Trump in tweets and comments has attacked the defense contractors on costs.

He targeted Boeing Co (BA.N) on Dec. 6 with tweets for “out of control” costs on new Air Force One planes and said the order should be canceled.

On Dec. 12 Trump slammed Lockheed Martin Corp’s (LMT.N) F-35 fighter jet program as too expensive. On Monday Trump said he and Lockheed Martin had trimmed $600 million from the latest contract to buy 90 of the F-35 fighters.

But Lockheed’s shares ended Monday’s session little changed, and analysts downplayed news of the cuts, saying they were likely already being planned by the company, which is the Pentagon’s No. 1 weapons supplier.

“We do not think this is anything new, or material,” Jim Corridore, airlines and logistics analyst for CFRA Research, wrote in a note this week, adding that the firm is keeping a “strong buy” recommendation on Lockheed. “Overall, we think the F-35 is likely to be a strong driver of EPS for LMT.”

Air Force Lieutenant General Chris Bogdan, who runs the F-35 program for the Pentagon, had said on Dec. 19 that the cost per plane should decrease about “6 to 7 percent” for this the 10th batch of the stealthy jets.

Lockheed shares are now up 5.1 percent since the election. Shares of Boeing, which has a much higher percentage of its revenue coming from non-government projects, have risen about 15 percent since the election.

The F-35 program is critical to Lockheed’s results, with a roughly $2 billion increase in its fourth-quarter revenue attributed mostly to higher sales of the jet fighter.

Investor interest in the space remains high.

The iShares aerospace and defense fund (ITA.P) has had inflows in 10 of the 12 weeks since the election, according to Thomson Reuters Lipper data.

The ETF is up 9.3 percent since the election, while the S&P 500 aerospace and defense index .SPLRCAED is also up about 9 percent in that time, compared with a gain of 6.5 percent in the benchmark S&P 500 .SPX

But valuations are up as well. The S&P aerospace and defense index is now trading at nearly 18 times forward earnings, its highest level in about 12 years, and above its median of about 15, according to Thomson Reuters data.

However, outlooks from some defense companies last week were less bullish than investors were expecting.

“The stocks got ahead of themselves,” and there’s still uncertainty ahead for the defense group, said Peter Tuz, president of Chase Investment Counsel in Charlottesville, Virginia.

Raytheon (RTN.N) forecast 2017 sales below analysts’ expectations, while Northrop Grumman (NOC.N), a supplier of parts for the F-35 jets, gave a weaker-than-expected earnings per share outlook for this year.

Trump’s plan to build a wall on the border with Mexico could benefit defense contractors that make border security systems such as remote video surveillance towers.

Reporting by Caroline Valetkevitch in New York and Mike Stone in Washington; Editing by Phil Berlowitz

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