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The Spade Defense Index
Interview – November 05, 2008
HDS: How has the sector performed during the market’s decline?
SMS: Although the fundamentals of the sector remain strong, highlighted by many of the firms reporting quarterly revenues and earnings consistent with forecasts and flush with cash on hand, defense, homeland security, and aerospace stocks have declined as the market retreated. For the year, the sector remains several percent below the performance of the S&P500 and has dropped by nearly half since its highs in October 2007. However, considering how undervalued the sector is at the moment, it wouldn’t surprise me, now that the Boeing strike is over, that the sector sees a bounce upwards.
HDS: You mentioned it is undervalued. How do you quantify this?
SMS: Well if you look at the fundamentals of the companies that represent the SPADE Defense Index, you’ll see that roughly half have single digit price-to-earnings ratios, many of them significantly below 10. In addition, roughly half the companies are seeing both price-to-sales and price-to-earnings growth (PEG) ratios of less than 1.0. These are measures that the defense sector hasn’t seen in at least a decade.
HDS: So what has been the biggest drag on the sector’s performance?
SMS: There were several factors, mostly driven by the huge negative sentiment for investing in stocks in general. As the market declined and news from the banking and housing sector dominated the news, investors who needed to raise cash, liquidated many of their positions, especially those that have gained the most. With the defense sector outperforming the market significantly over the past eight consecutive years, it was one of the first sectors to correct. The second major impact relates to Boeing. In addition to its stock being down more than 60% from its highs driven by delays in its 787 program, the recent two-month long strike impacted not only its short-term performance but those of its suppliers and business partners. With the strike settled, we should see a rebound.
>HDS: What about future spending on defense and homeland security?
SMS: I don’t see any major changes here under a new administration. While there will be some pressure from Congress to cut the budgets for both because of economic factors, comments from Barack Obama and his advisers indicate a recognition that world instability is still a major issue and we need to maintain a strong defense and homeland security sector.
There are several other things people should consider. First is that the budget for FY09 has already been signed into law and the 2010 budget will be submitted to Congress only a few weeks after the inauguration which leaves little time for major changes. In addition, the Department of Defense with input from Homeland Security will be working to prepare a new Quadrennial Defense Review that is due in 2010 and it is this document that will direct the strategy for the military for the next four years. As such the U.S. budget for defense and homeland security is likely to remain as currently forecasted for the next year or two – a more flat budget than in past years but with some growth and possible upside potential.
Of course, politics is always the wildcard. However, as I have mentioned in the past, I think that it would be political suicide for any politician to come out in favor of declining budgets for defense and homeland security. Right or wrong, in the aftermath of another terrorist incident, this single issue could not only cost them their job but that of their party.
HDS: So you are positive about the prospects for the industry?
SMS: Considering the level by which the defense sector has corrected, the undervalued nature of the sector considering the technical metrics, and what we know about the current budget, it would be hard not to see positives.
Disclaimers: The information presented in this interview is for informational purposes and should not represent a solicitation or an offer to purchase an investment product. SPADE and the SPADE Defense Index are registered trademarks of the ISBC. Powershares is a registered trademark of Powershares Capital Management.
For More Information:
Dawn L. Van Zant - President
800.665.0411 –
dvanzant@investorideas.com
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