The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.
NEW YORK (MagicDiligence.com) -- We believe defense contractors, home health agencies and for-profit education could face disproportionate hits from spending pullbacks as a result of the just-passed debt deal. The deal allows the federal government to raise the debt ceiling by $2.4 trillion. To balance this act, there is an initial $917 billion in spending cuts over the next 10 years. Additionally, a congressional committee will be appointed to find another $1.5 trillion in spending to cut, by Thanksgiving of this year. If the committee does not come to an agreement, a pre-arranged set of spending cuts will kick in (the "trigger cuts").
Let's take a look at the current Magic Formula stocks in three well-represented Magic Formula Investing sectors that are now at risk.
Defense ContractorsOver the years, defense contractors have enjoyed generally increasing budget dollars, combined with excellent competitive advantages stemming from long-term relationships with the Department of Defense, allowing good returns on capital. At the same time, due to a limited addressable market, investors have never bid up the stocks much, leading to relatively low valuations. This is a perfect scenario for showing up in the Magic Formula screens, and in fact, even in good times, this sector is a staple of the strategy.
Unfortunately, this is also probably the most obvious group hit by the debt-ceiling deal. Of the initial $917 billion in cuts, about a third come out of defense. Additionally, if the "trigger cuts" are reached, many analysts estimate another $600 billion, or more, will get taken out of defense. For firms that rely on federal defense dollars, this is a harrowing prospect.The Magic Formula stocks most affected are the ones that rely almost solely on the Feds for revenue. Lockheed Martin (LMT), Northrup Grumman (NOC), Raytheon (RTN), SAIC (SAI), and ManTech (MANT), all get 85% or more of revenue from the U.S. government. Other defense-oriented firms with a bit better private sector exposure include Harris (HRS), at ~65% exposure, and OshKosh (OSK), at 72% exposure. It is difficult to say exactly where the cuts will come, but it is likely that all of these firms will see reductions to at least some of their programs.
Home Health AgenciesGiven the growth demographics for America's elderly, home healthcare providers have offered investors the promise of a secular growth industry, combined with low capital requirements producing good returns on equity. The entire sector has been listed in MFI at one point or another over the past several years.
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