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HARRISON MILLER

The Israel-Hamas War: Impact On And Outlook For Defense Stocks

A simple fact: Wars require supplies. And many of the tools used in modern warfare are very expensive and difficult to manufacture and obtain. As a result, the eruption of war, whether in Ukraine or Israel and the Gaza strip, generally sends the price of at least some defense stocks higher.

Among the world's current conflicts, Russia's assault on Ukraine and Israel's response to the Oct. 7 attack by Hamas have occurred under very different circumstances. It is worth taking a look at some of the similarities and differences in how defense stocks have so far responded to the two outbreaks.

Defense Stocks Surge

The Aerospace/Defense sector jumped 4.6% on Oct. 9, MarketSmith data shows, the first trading day following the Hamas attack on Israeli citizens. Despite the initial jump, the industry group posted marginal gains in the following days. The 67-stock group rose just over 2% from Oct. 6 to Oct. 26.

Defense contractors small and large posted gains during the period. Rising names included AeroVironment, Kratos Defense, Lockheed Martin, Northrop Grumman, L3Harris, RTX, formerly known as Raytheon, General Dynamics, BAE Systems and Rheinmetall.

AeroVironment jumped 12% while Kratos Defense climbed nearly 14%. Both stocks are near highs and in basing patterns

Lockheed Martin surged a bit more than 12% from Oct. 6 to Oct. 26, also benefiting from an Oct. 17 earnings beat. Northrop Grumman rallied almost 15% during that period. L3Harris is up about 8% since the Hamas attack, with most of its gains occurring on Oct. 9. General Dynamics also posted its largest gain on Oct. 9 and is up nearly 10%. RTX surged 4.8% from Oct. 6 to Oct. 23 after trading near its lowest level since February 2021. RTX stock also spiked following its Oct. 24 earnings beat, putting it ahead more than 14% since Oct. 6.

Boeing stock climbed 4% by Oct. 11 before shedding the gains, now down 4% over the period.

U.K.-based BAE Systems, which trades in American depositary receipts (ADRs) under the ticker BAESY on OTC markets, leapt 11.7% by Oct. 24. German defense manufacturer Rheinmetall also trades over the counter as RNMBY and RNMBF. Its shares have rallied about 15%.

Israel Punches Back After Hamas Attack; Missile Strikes Define Conflict

The Ukraine War Effect

In February 2022, the initial market response to the start of the Ukraine conflict was similar.

Stocks in the Aerospace/Defense group collectively surged about 7.7% in the first two weeks after the Russian invasion of Ukraine on Feb. 24, 2022. The group had climbed 12.3% by late March 2022. It then retreated nearly 20% to mid-June on macroeconomic pressures.

Rheinmetall soared 94.6% between Feb. 23 and May 31, 2022, after entering a strategic cooperation agreement with Ukraine's state-owned Ukroboronprom. Rheinmetall offered repair and maintenance services for combat vehicles. It also manufactured Lynx infantry fighting vehicles and Panther battle tanks.

The stock is up nearly 138% since Feb. 23, 2022.

AVAV stock rallied 61.5% during the February to May period in 2022, apparently fueled by AeroVironment's involvement in missile and drone production. The Arlington, Va.-based outfit manufactures Switchblade "suicide" drones that have been utilized in Ukraine since the beginning of Russia's invasion, as well as Puma hand-launched recon drones.

AVAV is trading about 47% above its Feb. 23, 2022 price.

Gauging Defense Vs. Broader Market

Also in the February to May 2022 time period, Northrop Grumman stock vaulted 21.2%, boosted by its involvement in supplying counter-drone vehicles and systems. Elbit Systems, which makes artillery and tank shells, unmanned air systems and rockets, jumped 18.2%. L3Harris Technologies, Lockheed Martin and BAE Systems rose between 11.4% and 17% during that time frame.

RTX, General Dynamics and Heico posted subtler gains at the beginning of the war, rising between 3% and 4%. TransDigm faded 3.5%. Boeing, which sees its defense trade moderated by its commercial aerospace business, tumbled 33% during the period as countries implemented travel bans to Russia.

Still, defense stocks largely outperformed the broader market in 2022. The SPDR S&P 500 ETF fell 19.4% over the year according to IBD return data. The overall Aerospace/Defense industry group climbed 5.8% in 2022.

Northrop Grumman spiked nearly 41% last year. BAE Systems and AeroVironment posted 38% gains. Lockheed Martin soared roughly 37%. General Dynamics jumped 19% while RTX rose 17.3%. Rheinmetall bolted nearly 120% higher.

Elbit Systems fell 5.8% on the year. L3Harris slid 2.4% while TransDigm eased about 1%.

Impact On Defense Stocks: Analyst Outlooks

Congress approved $113 billion in aid to Ukraine in 2022, according to the U.S. State Department Office of Inspector General and the Committee for a Responsible Federal Budget.

The Israel and Hamas war could drive up Department of Defense investments, BofA securities wrote in an Oct. 10 research note, reported by TheFly. The U.S. has, housed in Israel, a strategic stockpile of weapons described as "vast and unknown" by the New York Times. A "potentially longer conflict" could force the U.S. government to order and purchase additional munitions and weapons systems.

Ultimately, the U.S. will support Ukraine and Israel by supplying munitions, missiles and antimissile systems to the allies, BofA wrote. Companies primed for the potential boost include General Dynamics, Lockheed Martin, RTX and L3 Harris due to their exposure to missiles, propulsion systems, land defenses and munitions.

Defense Stocks Under-Owned, Shorted

TD Cowen, on the other hand, doesn't expect to see much of a sales boost for defense contractors according to an Oct. 10 research note reported by the Wall Street Journal. Defense giants like Lockheed and RTX were already increasing production of ground-warfare items, so an increase in demand still won't provide a meaningful bump to profit or sales, the firm wrote. TD Cowen sees Lockheed Martin, RTX, L3Harris and Northrop Grumman as best-positioned to benefit if there is greater demand for defense products.

JPMorgan analyst Seth Seifman agreed the direct impact of the Israel-Hamas conflict on defense contractors is small in an Oct. 11 research note reported by Barron's. The initial spike likely reflected positioning, as defense stocks were under-owned or shorted, he wrote. Violence in the Middle East may have helped spur the House of Representatives to elect a Speaker and could generate added support for the Defense Department budget.

"The attacks also increase the likelihood of a broader war, though stocks are not pricing this in," Seifman wrote. He rates General Dynamics stock a buy with hold ratings for the other major defense names.

The White House requested a defense budget of $886 billion for fiscal 2024, a 3.3% year-over-year increase.

U.S. Commitments To Israel

The U.S. signed an agreement with Israel in 2016, pledging $38 billion in military aid over the next decade. Of the funding, Israel has to spend $1.2 billion per year on advanced U.S. military equipment. The deal bolsters U.S. defense companies' profits in international markets and enhances the flow of U.S. weapons to Israel, according to Zacks Investment Research.

The U.S. deployed two carrier strike groups in mid-October. The Gerald R. Ford strike group is off the coast of Israel in the Mediterranean Sea. The Dwight D. Eisenhower strike group was reportedly passing through the Mediterranean and Suez Canal, according to U.S. Naval Institute News. The two carrier groups in the Mediterranean Sea marked a historical staging of naval resources.

"That's probably more ships that we've had in that area since 1993," Adm. James Foggo, former commander of U.S. Naval Forces Europe-Africa, told USNI News.

The Pentagon also sent the three-ship Bataan Amphibious Ready Group, as well as additional A-10, F-15, F-16 and F-35 warplanes, to the region to augment its fighter squadrons.

The F-35 is manufactured in collaboration between Lockheed Martin, Northrop Grumman, BAE Systems and RTX's Pratt & Whitney division. Boeing manufactures the F-15. The F-16 fighters are made by Lockheed and General Dynamics. Northrop Grumman leads production for the A-10 with support from Boeing.

About 2,000 U.S. troops were placed on prepare-to-deploy orders for possible support to Israel, NBC News reported Oct. 16, citing a defense official.

More Spending On Military Resources Likely

President Biden proposed a $105 billion national security package that includes assistance to Ukraine and Israel on Oct. 20. The funding request allocated $61.4 billion in aid for Ukraine and $14.3 billion for Israel. Of the aid to Ukraine, $44.4 billion will go to the Department of Defense to replenish military stocks, which will "support the U.S. industrial base," CNN reported. About $10.6 billion of the funds requested for Israel will go toward military aid including air and missile defense support, industrial base investments, and replenishing U.S. equipment being drawn down to support Israel.

The proposal also includes assistance in procuring components for the Iron Dome and David Sling System, which makes up Israel's missile defense system. It allots $3.7 billion for the State Department to strengthen Israel's military and bolster U.S. Embassy security.

The request also includes $9.15 billion for humanitarian assistance to Ukraine, Israel, Gaza and Palestinian refugees.

Defense Stocks To Watch

Defense contractors will be heavily involved in the Israel-Hamas conflict, even if analysts don't expect much of a boost to financials. RTX's missiles and defense unit collaborates with Israel's Rafael Advanced Defense Systems in forming the Iron Dome, the David Sling System and missile defense batteries.

National Security Advisor Jake Sullivan said during an Oct. 10 interview with the DoD that the U.S. began providing additional Iron Dome interceptors to Israel.

The Israel Air Force has been using Lockheed Martin's C-130 transport aircraft and F-16 fighter jets since the 1970s and 1980s, Zacks Investment Research wrote in an Oct. 11 note. Israel owns the largest F-16 fleet outside the U.S.

Zacks rates RTX, Lockheed Martin, Boeing and L3Harris as best-positioned for growth opportunities. Israel Aerospace Industries — Israel's leading aerospace manufacturer — provides major structures for Boeing's F-15 program as well as parts for the V-22 Osprey, T-38 Talon and T-45 Goshawk. The company also won contracts to deliver four KC-46A tanker aircraft to Israel last year. And Boeing announced plans to expedite the delivery of 1,000 smart bombs to Israel, according to Oct. 10 reports.

Defense & Aerospace Stocks To Watch And Industry News

Elsewhere, L3Harris expanded its partnership with Israel Aerospace Industries' ELTA Systems Group in July to provide Airborne Early Warning and Control (AEW&C) solutions to alert for incoming attacks.

Shore Capital analyst Jamie Murray sees BAE Systems as the top beneficiary in the sector if the Israel conflict spills over into a more regional conflict, according to an Oct. 10 research note reported by the WSJ. BAE Systems' limited presence in Israel and its drone and anti-drone technology should provide a boost, given rising demand for military hardware, communications and intelligence products.

AeroVironment stock and Kratos Defense shares are setting up in bullish patterns following the recent rally.

You can follow Harrison Miller for more stock news and updates on X/Twitter @IBD_Harrison

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