Citi makes bull case for defense stocks and gives its favorite picks

Wall Street is underappreciating the growth outlook for the defense sector, according to Citi. Witness the fact the SPDR S & P Aerospace and Defense ETF has risen about 6.1% year to date, lagging the S & P 500 ‘s 9.6% gain. Nonetheless, Citi remains confident in “the bull case for defense.” Fueled by “budget gimmicks in D.C. and headlines in the media,” many investors believe U.S. defense spending has stopped growing, according to analyst Jason Gursky. In reality, both the data as well as political rhetoric undercut that argument. What’s more, European countries are raising their defense budgets, he added. Defense companies historically trade at a premium to the rest of the market when defense budgets grow, Gursky said. “In our view, that’s the likely set-up through 2030 with stocks poised to see significant appreciation should investors better abide to this narrative. To get us there, we’ll likely need to see several quarters of [profit] margin expansion across the industry and a more normalized Congressional budget process,” said Gursky. Citigroup argues that defense companies warrant a much higher growth rate than the 0% to 3% assumption investors are currently pricing in. Meanwhile, the current 15% rate of backlog growth over the past three years suggests broader sector growth of around 5%, Gursky added. “Further, margins are likely to expand as recent bookings better reflect the current cost and supply chain environment. In our view, investors should look to invest in companies with accelerating revenue growth and margin expansion,” Gursky wrote in a Monday note. Here are some of Citi’s favorite defense picks, all of which have a buy rating from the bank. Leidos Holdings has surged 36% in 2024, pushing the stock up nearly 85% over the past 12 months. The cybersecurity company’s “diversified government contracting allows for multiple shots on goal,” Gursky said. The analyst believes Leidos has margin growth potential and improving risk assessment and mitigation systems. His price target of $165 suggests shares gaining an additional 12% from Friday’s close. Gursky noted that while Leidos has a healthy balance sheet, it is at risk of higher interest expenses in the future. LDOS 1Y mountain Leidos Holdings over the last 12 months Citi is also bullish on Lockheed Martin . The prime contractor for the F-35 is a beneficiary of U.S. and rising European defense spending, according to Gursky. The analyst calculated European countries increased their defense spending 13% year over year in 2023. Lockheed Martin’s “emphasis on shareholder cash returns [is] likely to continue,” Gursky said. Some of the catalysts ahead for Lockheed Martin include production and orders for both F-35 and F-16s as well as C-130 transports, Gursky noted. That said, Lockheed’s necessary investment and longer-term competitive edge in its Space business remain key questions hanging over the stock. Lockheed is higher by less than 5% year to date and over the past 12 months, lagging the broader defense sector. Citi’s $525 price target implies almost 12% upside from Friday’s close. LMT YTD mountain Lockheed Martin shares in 2024 Science Applications International Corporation is a “technology integrator that is well-positioned,” Gursky wrote. Shares of the government services and IT company have rallied 9.5% in 2024. Consistent revenue and EBITDA growth in the coming quarters will be upside drivers for SAIC, Citi said. Gursky’s $155 price target implies about 15% upside. SAIC YTD mountain Science Applications International Corps. in 202