After strongly outperforming the broader market in 2022, defense stocks are poised to have another solid year in 2023, according to Morgan Stanley. The group has had some weakness in the first few weeks of January after surging roughly 20% in 2022 while the S & P 500 fell about 19%. “The move lower in 2023 has partly been driven by a shift in sentiment after reports emerged indicating that House Republicans may be gearing up to oppose wider spending, which could alter the US defense budget’s growth trajectory,” wrote analyst Kristine Liwag in a Thursday note. “We also see profit-taking after a strong 2022 contributing to the recent selloff.” Still, the firm thinks it’s a good time to buy defense stocks. “In our view, potential cuts to the Defense budget are not a slam dunk and we could see sentiment reverse should fears of deep cuts, which we see as overblown today, start to ease,” Liwag said. Liwag also views current 2023 outlooks that show modest topline growth and flat to slightly down margins as conservative. The forecast doesn’t account for the roughly $45 billion in higher defense spending for the full year 2023 that was signed into law in December. That means there’s potential for revised higher outlooks, which would provide a tailwind for the sector, she said. The top defense stock Morgan Stanley’s top pick in the industry is Northrop Grumman , a global aerospace defense company that’s slumped about 18% year to date after outperforming in 2022. The recent pullback in the stock’s price provides “an attractive opportunity to accumulate shares,” said Liwag. The firm reiterated its overweight rating and its $626 price target implies more than 40% upside from the stock’s Wednesday close. NOC YTD line Northrop Grumman has slid about 18% year to date. Even though it’s expensive compared to its peers – it trades at a roughly 15% premium to other names in the space – Morgan Stanley sees few substitutes for its “best-of-breed portfolio and continues to view the stock as the defense ballast to own,” said Liwag. It also makes sense given changes to the U.S. defense budget and potential economic weakness ahead, she said. “We see NOC well-aligned to some of the fastest-growing areas of the US defense budget, including space and nuclear modernization,” she said. “We also see particular durability in NOC’s portfolio and expect its programs to remain well-funded even if defense spending is pressured, limiting downside risk in a Bear scenario.”
© heardonwallstreet.com