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Analysts Take Dim View of Defense Sector Earnings

NEW YORK ( TheStreet) -- Investors shouldn't expect strong fourth-quarter earnings from companies in the defense sector, analysts said.

Morgan Keegan analyst Brian Ruttenbur said following L-3 Communications' (LLL) reduced revenue and earnings guidance -- the company sees 2012 revenue falling 5.5% and EPS down about 2% -- he expects similar revenue declines from the major defense companies, such as Lockheed Martin (LMT - Get Report), Northrop Grumman (NOC - Get Report) and Raytheon (RTN - Get Report). L-3's projected 2012 sales are between $14.4 billion and $14.6 billion, with EPS of between $8.35 and $8.55.

Ruttenbur has hold ratings on all the major defense companies. He cited the Department of Defense's plan to cut about $487 billion over the next 10 years from its budget, as a challenge for the sector.

Other analysts note the exit of American forces from Iraq at the end of 2011 and the expected departure of about 30,000 troops from Afghanistan in the summer of 2012 as headwinds for the industry.

Looking at Lockheed Martin's fourth-quarter earnings, which are scheduled to be released on Thursday, Lazard Capital Markets analyst Michael Lewis said investors should watch the company's share buyback activities as a very aggressive move could cause an earnings beat. Other than that, Lewis doesn't hold out much hope for strong earnings for Lockheed; his revenue estimate of $12.03 billion is about $250 million below the consensus of $12.29 billion and his earnings per share estimate is $1.85, below the average analyst estimate of $1.94, according to data from Zacks. Lewis anticipates that Lockheed's space operations will be down in the fourth quarter but could see some growth in 2012.

Lewis has a neutral rating on Lockheed Martin in part based on F-35 inventory being pushed further out. He anticipates the plane to be a smaller contributor to earnings for the next two to three years.

"This is a well-managed company but it will feel the brunt in program reductions like other defense companies," Lewis said.

If Lockheed Martin is going to have any kind of upside earnings surprise, Lewis thinks it will be from an unexpected amount of additional research and development revenue or an early procurement of funds in the space area. He doesn't anticipate either of these things to happen, however.

TheStreet Ratings gives Lockheed Martin an A- grade and a buy rating with a price target of $96.69. The stock closed Friday at $82.78. Shares of Lockheed Martin have risen 2.06% year to date.

For General Dynamics (GD - Get Report), Lewis forecast fourth-quarter earnings per share of $1.99, slightly below the $2 average analyst expectation. The average analyst estimate on revenue is $9.29 billion.

Lewis doesn't expect the focus of the fourth-quarter report to be on the company's defense area; instead eyes and ears will be on the G650's delivery and guidance. Lewis anticipates 10 deliveries in this model; the company said it would be between 10 and 12.

The G650 is one area General Dynamics needs to get right this quarter because if it doesn't deliver the minimum number it projected, the stock could see a selloff even if the company beats revenue projections.

Lewis considers General Dynamics a buy with a price target of $81. The stock closed at $72.47 on Friday. Lewis noted that General Dynamics seems to be growing its maritime business more than its peers.

TheStreet Ratings gives General Dynamics a B grade and a buy rating with a price target of $83.40. Shares of General Dynamics have risen 9.56% year to date.

Growth investors shouldn't be in the defense sector right now, said Morgan Keegan's Ruttenbur, adding that they should wait until the next war happens, historically speaking, in about 10 years. But for value investors who are looking for a place to hide their money, the defense sector is a good place to be in particularly during an election year, Ruttenbur said.

Since earnings growth in the sector is tied to defense sector budget growth, Sterne Agee analyst Peter Arment has a cautious outlook on investing in the sector. Investors who are looking for growth should aim for companies that are less closely tied to defense.

He recommends General Dynamics, which has about one-third of its business related to the defense sector. Arment is bullish on the company's higher-end G650. It could have more than $3 billion in annual sales by 2014 by Arment's estimation, and he anticipates sales growth thereafter.

United Technologies (UTX - Get Report) has less military exposure and will benefit from a pickup in commercial construction, said Drexel Hamilton analyst Rick Whittington. With the Goodrich merger, less than 10% of the company's sales will be related to the military, Whittington said.

"In 2012, we expect moderate economic growth driven mainly by emerging markets, and four of our five business units expect solid organic sales growth," CEO Louis Chênevert said in a statement. "Relentless focus on cost reduction and productivity while investing in innovative technologies will position us to grow earnings per share 6 to 10% in 2012, excluding Goodrich, despite significant pension and foreign exchange headwinds."

United Technologies anticipates 2012 earnings per share to be between $5.30 and $5.50, which factors in some dilution from the Goodrich acquisition.

Whittington said he expects to see earnings per share growth from United Technologies at least through 2015. Next year's earnings per share are estimated at $6.55 a share; in 2014 they are $7.41; in 2015 they are $8.11.

United Technologies' Pratt & Whitney division, which makes aircraft engines, had net sales of almost $3.3 billion in the third quarter, making the division United Technologies' third biggest by sales. Whittington said he anticipates that the division will see five-year compound annual sales growth of 7.3% from 2011 through 2015, an increase from the 7% compound annual sales growth from 2006 through 2010.

Increased non-residential construction should also be beneficial for United Technologies, Whittington said.

"Already seeing clear signs in the latest ISM reports of improved non-residential construction demand that bodes well for Carrier and Fire & Security as well as Otis," Whittington said of the United Technologies divisions.

Whittington has a price target of $85 on United Technologies. TheStreet Ratings gives United Technologies a B and considers the stock a buy with a price target of $89.15. United Technologies shares closed Friday at $76.69. Shares have increased 5.84% year to date.

More than 60% of Boeing's (BA - Get Report) business is related to commercial development and that will increase to more than 70% in about the next four years, Whittington said. Boeing's third-quarter commercial airplane revenue increased 9% to $9.5 billion. The division's backlog has more than 3,500 airplanes which are valued at $273 billion.

Boeing got one of its largest orders ever in December from Southwest Airlines (LUV) for 150 737 MAX planes and 58 next generation 737s. The company had a total of 805 net orders in 2011; it also delivered 477 airplanes and has a backlog of 3,771 unfilled commercial orders.

Boeing is also increasing its production for the next two years to meet higher demand by making 38 737 planes a month, up from 35 a month, and 10 787s a month, an increase from 2.5 a month.

"This robust new orders picture in a period of disparate economic signals underscores views that the present civil airliner production cycle has long legs and is liable to highly profitable once delivery schedules settle down," Whittington wrote in a report.

TheStreet Ratings gives Boeing a B and considers the stock a buy with a price target of $87.27. Whittington's price target is $90. Boeing shares closed Friday at $75.52. Shares have risen 3.57% year to date.

-- Written by Alexandra Zendrian



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