The ongoing geopolitical tensions between Russia and Ukraine has, understandably, stoked market volatility. This is down to fears that Russia will invade Ukraine as soon as this week.
Amid the uncertainty, some investors have diverted their investments into specific aerospace & defense companies that could see tailwinds from unrest.
In a way, it makes sense since spending on defense is essential for the developed world and has consistently seen increases.
Here is a list of the top defense contractors, compiled by Bloomberg.
Each corporate specialises in different areas to meet military and defense needs. While all of firms listed above are likely to benefit from the rise in defense spending, I believe that the Northrop Grumman Corporation (NYSE: NOC) is a standout.
That’s because it will be among the best defense stocks to own over the next decade. This is mainly due to the change of dynamics in the industry.
Over the last 20 years, spending on defense in the US has primarily focused on counterinsurgency and antiterrorism, benefitting ground vehicles, aircrafts, drones and missiles.
There is, however, a shift towards peer-to-peer competition with China and Russia, which have also invested heavily in long-range weapons like hypersonic missiles and anti-satellite technology.
Amid the evolving dynamics of the defense industry, I think Northrop Grumman is the defense stock to own for the next decade. Here are two reasons why.
1) High-tech defense system that supports future growth
Northrop Grumman is a major player in the defense and aerospace business in the US. The company has platforms that have decades-long lifecycles and support future growth through modernisation and upgrades.
What is interesting is the company’s diversified revenue streams across four sectors, in particular the space systems.
The space systems business is the second-largest unit for the company with US$10.6 billion in revenues, derived from satellites, ground systems, missile defense systems and launch vehicles.
Northrop Grumman’s focus on space and cyber positions its business towards better growth area as compared to other defense companies.
It is also the key partner in NASA’s Artemis program, which provides solid rocket motor boosters and launch abort motors for the Space Launch System rocket.
Northrop Grumman will also benefit from the two other major platforms – Ground-Based Strategic Deterrent (GBSD) and the Next Generation Interceptor (NGI).
The GBSD is a future intercontinental ballistic missile and Northrop Grumman is the sole-source prime contractor for the US$13.3 billion programme.
As for the NGI, it is an US$18 billion programme to develop a ground-based midcourse missile defense system. The company won part of the initial US$1.6 billion contract.
In 2021, the company faced some near-term headwinds from the supply shortage amid the COVID-19 pandemic. Despite these challenges, earnings have remained resilient.
2) Dividend safety is excellent
Aside from the growth opportunity, I think that the dividend safety of Northrop Grumman is excellent – which is a boon for income investors in the current environment.
This is based on its resilient earnings, free cashflow, manageable debt level and a dividend payout ratio of only 24%.
While its dividend yield is only 1.6%, it’s still higher than the S&P 500 Index’s dividend yield of around 1.2%.
Based on its historical dividend payout, the company also offers dividend growth potential to long-term investors (see below).
Perfect combination of value and growth
While shares of Northrop Grumman have gained momentum recently, mainly due to the geopolitical tensions in Ukraine, investors should focus on the long-term return of their investment.
The long-term growth of defense companies – including Northrop Grumman – relies on governments’ military spending and is usually at a modest level of around 3% to 4% per annum.
However, given its exposure in the space business, I believe growth in Northrop Grumman will outpace its peers in the defense sector.
Aside from that, its superior dividend safety and growth are also suitable for those investors looking for passive income.
Disclaimer: ProsperUs Investment Coach Billy Toh doesn’t own shares of any companies mentioned.
