I invest in defense stocks. And for the longest time, the defense stock that's consistently appeared to be the best value stock on my radar is military shipbuilder Huntington Ingalls (HII -0.64%), the company that builds about half of America's nuclear submarines and all of its super-expensive nuclear-powered aircraft carriers.
Now, as you may have noticed, global conflict has been front of mind, with Russians invading Ukraine, Houthis targeting ships in the Red Sea, and China sending warships to bully neighbors (and build artificial islands) in the South China Sea. Given the environment, it's no surprise that a lot of defense stocks have gotten rather expensive, trading at 150%, 200%, and, in one notable case, 300% of their historical average valuation of 1 times annual sales.
Not Huntington Ingalls, though. Valued at just 14.4 times trailing earnings, and 0.9 times trailing sales, Huntington Ingalls today is the only defense stock that currently meets my standard of costing under 1 times sales.
Once cheap, always cheap?
One thing, however, has kept me from buying Huntington Ingalls stock. Yes, Huntington Ingalls stock looks cheap, but Huntington Ingalls stock almost always looks cheap. (The implication is that what looks like a cheap price might not really be a cheap price if it never moves higher).
Over the past decade, Huntington Ingalls stock has ranged from as low a valuation as 0.5 times sales to as high as 1.6 times sales. But its valuation has averaged about 1.1 times sales. This suggests to me that at 0.9 times sales, is probably a bargain, yes -- but not a huge bargain.
And yet, there's a big catalyst that could transform it into a huge bargain.
Why now could be a great time to invest in defense contractors
The world has become a dangerous place, but you wouldn't know it from the U.S. defense budget. While media pundits may complain about defense spending and how it's more than what most other countries spend, here's the cold, hard truth:
America currently spends just 3.4% of gross domestic product (GDP) on defense, which is roughly the same amount spent in the peaceful Clinton years -- after the fall of the Soviet Union, after the end of the first Iraq war, and before Sept. 11 and the "Global War on Terror" began. As a percentage of GDP, it's not the absolute least we've ever spent -- but it's close.
Data source: SIPRI Military Expenditure Database, chart by author.
And to be blunt, military experts say that's not enough. They're especially concerned about spending on the U.S. Navy's industrial base. This is where U.S. defense stocks, especially shipbuilding stocks, such as General Dynamics (GD -0.81%), Northrop Grumman (NOC 0.24%), and Huntington Ingalls, in particular, come in.
In the Summer 2024 issue of American Affairs Journal, Capt. Jerry Hendrix (USN, retired) warns of the "looming" risk of a "hot war with China" and the sorry state of America's navy to defend against this threat. Chinese DF-21D "Carrier Killer" ballistic missiles have essentially forced U.S. aircraft carriers out of the South China Sea. At the same time, the number of American submarines (which are immune from this threat) has fallen to critically low numbers, declining from 140 boats at the end of the Cold War to just 67 today. Only 49 of today's submarines are "fast attack" submarines usable in a conventional war, and 16 of these are currently waiting in line for required maintenance.
Arguably, the strength of the warship fleet, which is most useful for taking on China, has fallen 75% from its peak.
What's to be done?
Hendrix argues forcefully for the need to double the rate at which America builds nuclear submarines. He also blames a lack of U.S. shipbuilding capacity, skilled shipbuilders, and drydocks needed for maintenance for the fact that there's a three-year backlog of boats awaiting maintenance. And he argues that Congress needs to pass a "Ships Act" on the scale of the 2022 Chips Act to rebuild both American shipbuilding capacity and the ability to maintain warships once built -- and counter the nearly $200 billion per decade that China is spending to subsidize its own shipbuilding industry.
Nor is he alone. In recent months, everyone from Congressional leaders to the International Association of Machinists and Aerospace Workers have taken to the pages of The Wall Street Journal to argue there's an urgent need to rebuild America's shipbuilding infrastructure and its navy.
While there's no guarantee that this will happen, the proverbial Winston Churchill quote does seem appropriate here: "You can always count on the Americans to do the right thing after they have tried everything else."
America needs more submarines, which General Dynamics, Huntington, and Northrop Grumman (in its own special way) all build. We need more shipbuilding sites, too, which two of these companies, General Dynamics and Huntington Ingalls, know how to operate. However, one of these three stocks, Huntington Ingalls, is the only major defense stock that currently sports an attractive valuation.
If and should a "Ships Act" get passed, Huntington Ingalls stock will go to the top of my shopping list.
