Citi's Jason Gursky talks the bull case for the defense sector

Key Concepts:

• Defense sector investment outlook
• Aerospace sector investment outlook
• Rising defense budgets in the US and Europe
• Beneficiaries of the 2025 budget and future appropriations
• International sales growth for US defense companies
• M&A activity in defense tech and commercial space
• Unmanned, autonomous, and attributable mass in defense

Defense Sector Outlook and Earnings Expectations

• Citi is constructive on defense names going into earnings season.
• Rising budgets in the US and Europe provide visibility for defense companies.
• Specific companies mentioned as favorites: Huntington Ingalls, Northrop Grumman, RTX, Lockheed Martin, L3 Harris, General Dynamics.
• Expectations for earnings calls: growing bidding activity, future bookings outlook, potential for margin expansion as poorly performing post-pandemic programs end and new, margin-accretive contracts are signed.

Impact of the 2025 Budget and Appropriations

• The 2025 budget and the NDAA (National Defense Authorization Act) and appropriations bill for fiscal 2026 will benefit the entire sector.
• Priorities outlined by the president: air and missile defense, shipbuilding.
• Companies positioned to benefit from air and missile defense: RTX and Northrop Grumman (missile makers).
• Focus on shipbuilding due to the capacity gap between the US and China.
• Companies positioned to benefit from shipbuilding investments: Huntington Ingalls and General Dynamics.

International Sales and European Defense Spending

• International sales are expected to be a growing revenue component for US defense companies.
• European defense spending is projected to increase from 2-2.5% of GDP to 3.5% (pure defense) and 5% (including infrastructure).
• The US has historically spent 3-5% of GDP on defense and invested in new technologies.
• Europe lacks the IP, capacity, and advanced weapon systems, leading to increased purchases from US companies.
• Specific areas of European demand: air and missile defense, fifth-generation fighters like the F-35.

Defense Tech, Commercial Space, and M&A Activity

• Defense tech and commercial space are areas of high investor excitement in both public and private markets.
• The lessons from Ukraine highlight the need for unmanned, autonomous, and attributable mass.
• Private companies like Anduril are actively engaged in M&A to propagate their software across platforms.
• Large-cap companies considering acquiring defense tech companies need confidence in revenue pull-through at current valuations.

Conclusion

The defense sector is poised for growth due to rising budgets, international demand, and technological advancements. Companies involved in air and missile defense, shipbuilding, and unmanned systems are particularly well-positioned. While M&A activity is expected to continue, large-cap companies will need to carefully evaluate the revenue potential of defense tech acquisitions.