Al Root
Defense Secretary nominee Pete Hegseth wants to change the way the Pentagon awards contracts, which would have an impact on a host of companies -- from munitions providers to aircraft makers.
Hegseth headed to Capitol Hill on Tuesday for his confirmation hearing He mentioned the contracting process in written testimony that he intended to give before the Senate Armed Services Committee.
In his remarks, Hegseth said a priority was to rebuild the military "always matching threats to capabilities; this includes reviving our defense industrial base, reforming the acquisition process...modernizing our nuclear triad, ensuring the Pentagon can pass an audit, and rapidly fielding emerging technologies."
The nuclear triad refers to America's ability to launch nuclear weapons from land, sea, and air.
Triad reform isn't what investors will focus on. Instead, what will grab more attention is contracting reform and "rapidly fielding emerging technologies," which means accelerating the development and deployment of drones, unmanned systems, and hypersonic weapons.
Two stocks popular on Wall Street that fit that description are AeroVironment and Kratos Defense & Security Solutions.
AeroVironment has landed more government business for its guided munitions called SwitchBlade. Kratos develops unmanned aircraft as well as hypersonic technologies.
Overall, 69% of analysts covering Kratos rate shares Buy, according to FactSet. Almost 90% of analysts covering AeroVironment stock rate shares Buy. The average Buy-rating ratio for stocks in the S&P 500 is about 55%.
The average price target for Kratos is about $31 a share. On Tuesday, the stock was up 5.1% at $32.47. The average price target for AeroVironment is about $231; that stock was up about 2.5% at $166.11.
Three of the world's largest defense contractors were mixed. Lockheed Martin was down 0.6% at $480.63. Northrop Grumman was up 0.3% at $473.79. Boeing was down 0.8% at $$169.20.
The stocks were wobbling because of "reforming the acquisition process," which can be interpreted as moving away from cost-plus contracts -- the kind that many of the large defense companies provide.
Capital Alpha Partners analyst Byron Callan pointed out that moving to performance-based contracts, instead of cost-plus, doesn't necessarily mean disaster for contractors. It raises the possibility of higher margins. But the change still means some more uncertainty for the companies and their stocks.
In his remarks, Hegseth makes clear he is a defense hawk with a plan to revitalize the industrial military base.
"Serious investment targeted at systems that we truly need by also incentivizing competition and laser focus from the Office of Secretary of Defense to all the particular strategic initiatives," he said.
Hegseth added that spending less than 3% of America's gross domestic product on defense is "very dangerous."
That number implies a defense budget of about $900 billion annually, which is close to what it is right now. It also implies nominal growth of about 4% or 5% -- also similar to spending growth over the past few years.
That level of spending and growth supports the defense sector. Investors will have to determine if the winners and losers are changing -- and how fast change can come.
Write to Al Root at allen.root@dowjones.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
January 14, 2025 11:29 ET (16:29 GMT)
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