Defense Spending Surge Creates Opportunity in RTX, LMT & GD

SPEAKER_1 (0:00)

So joining us now for all the upcoming opportunities in the aerospace and broader defense space is Bill Whelan, portfolio manager and partner at Cloud Capital. Bill, thanks so much for joining us on this Tuesday. Now, defense stocks have seen a pretty substantial repricing, unfortunately, to the downside this year, despite ongoing conflicts around the world. And so what do you think the market perhaps then is missing about the long-term outlook for the broader sector?

Bill Whelan (0:24)

Thanks, thanks for the time. So I think the demand for defense equipment remains strong. It's been an interesting sector in that the defense primes have declined about 20 to 25% since the start of the conflict.

The defense tech companies have just declined about 50% since the start of the conflict at the end of February. So defense demand remains strong, but I think there are a few concerns. The market's struggling with how much Washington will spend, how quickly the industry can increase production, and then how much of that growth becomes earnings.

We are bullish. We like RTX, Lockheed, and General Dynamics, and happy to elaborate why we think there's an exciting cycle.

SPEAKER_3 (1:09)

Yeah, I want to get into some of those names in a moment, Bill, but I also want to discuss with you and get your thoughts on sort of what we've seen as sort of the trends of the last decade, of sort of, I guess, a deglobalization trend, what that's meant for individual countries across the world in terms of defense budgeting. The companies that you mentioned, and of course some of the other peers that are based here in the US still dominate when it comes to the technology they have. One would imagine that's even more opportunity for these countries. I think somewhere like Germany that might want to bolster the defense spending but doesn't necessarily have the companies to do so themselves.

Is that a positive for this industry, or is that something that they're going to have to battle against, that those countries try to ramp up their own companies to maybe close the gap?

Bill Whelan (2:06)

I think there's benefits to it, but there are trade-offs. European countries are absolutely planning on ramping up their defense spend. They are trying to keep defense spend to European countries. I think that's their starting point. But with that said, you look at RTX, their defense exposure just within the Raytheon defense, it's almost 47% international. Lockheed's about 28%.

So there's absolutely international exposure.

But a company like Ryan Mattal, and granted there are different business lines for each, that's a competitor in some cases. So I think the fact that spending is increasing both in the US and Europe is a positive for all defense companies. But it doesn't just go to the US companies.

SPEAKER_1 (2:56)

Okay, and so I want to talk about some of the earnings that we've already gotten, of course, this morning. And it seems like it's been a relatively mixed in terms of reaction as far as the street's concerned. But you mentioned you have some favorite picks here. And so walk us through then what is sort of working for you right now and what is giving you this sort of confidence as we approach, of course, the year end, I cannot believe we're almost at 2027

Bill Whelan (3:16)

Sure. Yes. So I mean, the 20 to 25% decline is, we see it as a major price opportunity. And I think a big part of that is, you know, just the upcoming budget uncertainty. And just for context, you know, going into 2027, the base budget is expected to be 1.1, but the administration has floated out a 1.45 billion dollar budget.

Depending on how things shake out in the next few weeks, the thought is, there might not be much reconciliation spending. I think the key thing is kind of just looking at what the base budget has done over the past few years. So 2024, it was 842 billion. 2025, 862

26 was about a billion. And then I think it's a pretty good bet to go to 1.1 billion. So about a 10 percent increase with just the base budget alone, and maybe we'll see some incremental spend with reconciliation. So I guess my thought is the fears, I think some of the budget fears that have pulled the stocks down are personally overdone. There's significant demand and as we think about some of our themes within the sector, missile replenishment is a key one and within that, we favor RTX and Lockheed Martin.

SPEAKER_3 (4:39)

Okay, Bill, final one I got for you, Jenny may have another, I'm not sure. But when we look at this space and really just investing broadly, I'm a big believer that surprise drives equity movement more so, certainly in the short term. But in the longer term, I'm a believer earnings drive it and the multiples are important. It seems like a lot of the selling this year has just been a contraction of the premium multiples that many of these stocks had carried.