Northrop Grumman Corporation

Northrop Grumman‘s (NYSE:NOC) Space Systems segment develops satellites, launch systems, and launch vehicles. The company has partnerships with NASA and other government agencies, providing a steady stream of revenue.

Like many space stocks, the company is well-positioned to benefit from growing demand for satellites, particularly for national security purposes. The company’s recent acquisition of Orbital ATK, a provider of rocket and missile systems, is also expected to provide significant revenue opportunities.

Unlike many space stocks, the company has a reasonable price-to-earnings (P/E) ratio of 14.9 times. This is considerably below the industry average of 31.6 times. By considering the discounted cash flow of Northrop Grumman, fair value of the stock at $547.34 is 12.4% above the current share price of $479.47.

Profits in the sector are fairly conservative, with Northrop Grumman expecting a decline in profits next year. Debt levels of 67% are also fairly high, but there is potential if solid fundamentals can develop over time.

Lockheed Martin (NYSE:LMT)

Lockheed Martin (NYSE:LMT) operates a Space segment developing satellites, space transportation systems, and various other classified systems and services.

The P/E ratio of the company is 22.4 times. This is slightly below the sector average, but now close to fair value based on a discounted cash flow calculation. One metric that may interest investors is a return on equity (ROE) of 73%. This indicates efficiency in use of investment, considerably higher than the sector average of 10.2%.

As can be the case with speculative areas such as space stocks, there has been a large amount of shareholder dilution in recent years. This means that investors hold increasingly less value. Debt to equity levels are high at 136.4%, indicating that the company heavily relies on debt rather than investment. However, with dividends growing steadily over the last decade, this strategy seems sustainable.

Raytheon Technologies (NYSE:RTX)

Raytheon Technologies (NYSE:RTX) operates an Intelligence & Space segment developing integrated space, communication, and sensor systems to government and commercial customers.

As with the companies mentioned previously, Raytheon Technologies recently acquired a provider of small satellite technology. This acquisition will diversify the product range.

The company has a higher P/E ratio than the previous two mentioned at 29.3 times. However, with a discounted cash flow calculation, the current price of $104.66 may be as much as 19.3% undervalued. The earnings growth forecast of 13.5% is higher than the industry average of 10.6%, but is still well below the overall market at 14.1%. ROE is also notably lower than competitors at 13.3%. The company clearly has steady growth, but is ineffective with use of investment.

Am I buying?

Space stocks will be an exciting area in the future. Commercial travel, exploration, and defence will be opportunities for investors. However, I will be staying clear until I see reduced debt and steady income across a range of sectors.

Hype and potential are always dangerous words for investors. Therefore, I don’t mind waiting for the right time to buy these companies at a better price.

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In addition to this volatility, investors today may favour companies with revenues now rather than far into the future, due to rising inflation and interest rates. We have witnessed this in real-time with the NASDAQ 100 (a proxy for technology stocks) officially entering a bear market (20% decline or greater) since its peak in November 2021. This could benefit the three companies mentioned below, in my opinion.

The first stock I may add to my portfolio is Shell, which should continue to benefit from a high oil price, as well as the transition to cleaner energy. Oil companies are under pressure by investors to be prudent with capital expenditure on new oil exploration, meaning a sustained higher oil price is likely. Since the market crash in March 2020, the oil price has risen over 300% and, although oil companies did cut their dividends following the crash, I believe this unlikely to happen again due to the huge energy expenditure needed to fuel the renewable energy transition (since all machinery, transportation, etc, still needs oil).

Lockheed Martin (NYSE: LMT) is a defensive company in every sense of the word. It makes fighter jets and other military weapons, as well as other combat machinery. The company has assured revenues because the majority of its business comes from government contracts. This allows it to pay a 2.6% dividend as it generates considerable free cash flow from the sale of its military equipment. Alongside this, the company has also been able to invest its profits into space exploration, a rapidly growing niche. This gives investors the benefit of assured revenue alongside an exciting growth aspect to Lockheed’s business at a reasonable 16x forward price-to-earnings ratio. The company should also benefit from increased defence spending by governments due to the Russia-Ukraine war.

Finally, Regeneron Pharmaceuticals (NASDAQ: REGN) and Bristol Myers Squibb are both extremely cheap, diversified ‘big pharma’ companies with strong free cash flow. Both companies’ share prices have remained strong during the market sell-off this year as investors seek defence in assets with more assured revenue streams. Regeneron has been under-appreciated by the market because of patent expiry for its Eylea drug, used to treat retinal diseases. Once drug patents run out, general pharmaceutical companies can recreate these drugs for a fraction of the price, rendering them worthless to the company that created them. Some of these patents don’t expire until 2030 and the company has a huge pipeline of potential drugs that could bring further revenue in the future. Both companies have recent momentum behind their share prices, and I see them as long-term holdings in my own portfolio.

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Given the continued development of technology, new markets such as space travel could potentially open up further for leading aerospace companies as well. Given the long-term growth prospects of aerospace, I’d buy and hold two aerospace stocks, Lockheed Martin (NYSE:LMT) and Rolls-Royce (LSE:RR).

A leading military aerospace stock

Making the world’s most advanced fighter jets at scale is one of the toughest things to do. It takes decades of research and development to come up with the necessary technology to make jets like the F-35 or F-22. It also takes decades of manufacturing experience to make those jets in a dependable and economical manner. Given the huge difficulties, Lockheed Martin has a very wide moat, which I think makes it an attractive stock.

Given how important defence is to the US and other countries, Lockheed Martin also has a huge backlog and a degree of stability that many other companies don’t have. In terms of its 2020 performance, for example, Lockheed Martin increased its backlog by around $3.2bn to close at around $147bn. In a year where many aerospace companies saw their sales decrease substantially, Lockheed Martin reported record revenue of $65.4bn and record segment operating profit of $7.2bn.

The future for Lockheed Martin could be attractive too. With all of Lockheed Martin’s research and development expertise in aerospace, I think the company could one day do well in space too. Given the nearly endless possibilities in space and the company’s moat, Lockheed Martin is a stock I’d buy and hold.

Lockheed Martin has risks if it doesn’t win as many new defence contracts as the market expects in the future or if management doesn’t manage costs well.

A leading jet engine maker

Like many aerospace stocks, Rolls-Royce shares didn’t do very well due to the pandemic. Fewer people flying have led to fewer total engine flying hours, which has led to lower sales for Rolls-Royce’s civil aviation unit.

With the current Covid-19 vaccine roll-outs, however, I think Rolls-Royce’s fundamentals could improve over the next few years as the vaccines eventually take effect. If civil aviation rebounds over the next few years as many expect, Rolls-Royce could potentially generate substantial free cash flow. With the free cash flow, management can pay down debt, pay a dividend, or invest in new growth areas.

Of Rolls-Royce’s future potential growth areas, air taxis propulsion systems may be one of the most promising. Given Rolls-Royce’s R&D expertise and their brand strength in aerospace, I think they could potentially succeed in that market if management makes the right decisions.

With that said, Rolls-Royce is at risk if the pandemic lasts longer than expected due to Covid-19 variants. The stock could also fall if management makes a bad M&A deal or if they don’t deliver the type of earnings the market expects.

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