A safe stock for an unsafe world
Defence spending is set to soar. That should be good news for this aerospace heavyweight
Russia’s invasion of Ukraine has alerted democracies to the dangers of dictators with expansionist ambitions. The results will include strengthening of protective alliances and increased spending on defence. Germany, which has long undershot the Nato target of 2% GDP on defence, is now preparing to exceed that. Japan, which is conscious of China’s threats to invade democratic Taiwan and the South China Sea islands, has set a record defence budget for 2022. Australia is increasing its defence force by one-third.
Defence companies are thus likely to see sustained growth in orders. I recommended Lockheed Martin, the world’s largest defence company, in June 2020 (up around 22% since) and I am now recommending the world’s second-largest defence company – Raytheon Technologies (NYSE: RTX), which was formed by the merger of Raytheon and United Technologies in April 2020.
A wide range of products
Defence accounts for 65% of Raytheon’s sales and this is likely to increase. The group has four divisions. Pratt & Whitney produces commercial and military aeroengines. Key products include engines for the Airbus A320neo and A220 airliners, the F-35 and F-16 fighters, Apache helicopters and research on high-speed military engines. Missiles & Defence makes the Patriot antimissile systems (the world’s primary land-based system), naval missiles, hypersonic missiles, space sensors to detect missile launches, radars, and command and control systems.
Collins Aerospace makes aerospace avionics, structures and systems for Airbus, Boeing, Lockheed, Embraer and Dassault and for US submarines and destroyers. Intelligence & Space, which again serves both military and commercial customers, covers airspace modernisation (surveillance, navigation, landing systems), battle management (command and control, land and satellite surveillance, electronic warfare planning and management) and hardening information systems against cyberattacks.
Developing new technologies
Raytheon’s research and development is focusing on areas include cyber-hardened connected systems (both commercial and battlespace), autonomy and artificial intelligence (unmanned aircraft, autonomous and semi-autonomous operations), propulsion (more sustainable commercial engines, nextgeneration military aircraft, hypersonics) and precision sensing and effects (space sensing, missiles and missile defence, directed energy weapons, electronic warfare). There are usually over 300 new ideas under assessment, with some gaining defence or commercial contracts.
Recent wins include a contract from the US Missile Defence Agency to develop and test the first interceptor to defeat hypersonic missile threats from Russia and China; an electro-optical system giving F-35 pilots an unprecedented 360-degree situational awareness and survivability; a joint Lockheed/Raytheon contract to build an Australian missile factory to counter threats from China; and a US Department of Energy contract to develop hydrogen propulsion technology for zero in-flight CO2 emissions, up to 80% reduction in NOx emissions and up to 35% reduction in fuel consumption.
Raytheon has a wide moat against competition based on extensive engineering knowhow and close relationships with defence procurement agencies. Its products have high switching costs: long-term defence contracts typically have upgrade programmes to extend products’ lives, with substantial aftermarket sales. Investors get a company in a very strong position, trading on attractive valuations (see below) and with the prospect of upwards earnings revisions for the coming years if further orders come in as defence spending increases around the world.
⬤ If you built up unused childcare vouchers during the pandemic, you may be struggling to spend them. The voucher scheme was closed to new entrants in October 2018, but existing members can keep buying childcare vouchers from their pre-tax salary, saving tax and national insurance. Yet some childcare providers are choosing to stop accepting vouchers “because of the paperwork involved”, says The Times.
Parents are free to switch to the new tax-free childcare scheme that replaced the vouchers, but “there is no mechanism for converting unused vouchers into deposits in tax-free childcare accounts”. What’s more, many vouchers have an expiry date. Those from Sodexo expire after 30 months, while paper vouchers from Computershare expire after 12 months although e-vouchers have no expiry.
⬤ If you are planning a trip to Europe with your pet, prepare yourself for a new bill. Since Brexit the EU has stopped accepting pet passports issued in the UK. You now need an animal healthcare certificate, which can cost £180. “The certificates are only valid for four months, meaning all but the most frequent trippers must pay each time they travel,” says The Telegraph. “These changes came into effect in January last year, but only now, as travel restrictions around the world are lifted, have they started to bite.”
⬤ “Interest rates on student loans are set to soar as high as 12%, costing higher-earning graduates an extra £3,000,” says The Guardian. Student loans taken out after 2012 are charged interest based on retail price index (RPI) inflation. This hit 9% last month, which will set the interest rate for graduates in England and Wales from September. The current rate is 1.5%.
Graduates who earn more than £49,130 a year are charged an extra three percentage points and will see their interest rise from 4.5% to 12%. High earners with £50,000 in student debt will accrue an extra £3,000 in interest between September and March 2023, when new legislation will cap the interest rate on student debt to be no higher than the rate charged by commercial lenders.