Defense Shares Rally on Spending Outlook

NEW YORK – Defense shares rallied Thursday as investors expected a hefty increase in Pentagon spending for weapons when the Bush administration lays out its budget next week, analysts said.

Strong fourth-quarter financial results, followed by bullish comments from Wall Street on the fiscal 2003 outlook, also helped lift some shares, analysts said.

The Standard & Poor's aerospace and defense index rose 4 points to 221.42 on Thursday, driven higher by shares of Northrop Grumman Corp., L-3 Communications Holdings Inc. and General Dynamics Corp.

"Very simply, we had the State of the Union and (Defense Secretary Donald) Rumsfeld is making comment on the defense budget today in Washington," said Nick Fothergill, analyst at Banc of America. "That's one of the reasons the stocks are running up today."

Rumsfeld, set to speak at the National Defense University on Thursday, was widely expected to make the case for higher spending.

Fothergill said that on Monday, when the Bush administration details its budget, it would likely include a 10 percent increase in defense procurement spending. Research and development spending could climb by 16 percent, he said.

Bush is seeking a $48 billion budget increase overall to about $379 billion for the Defense Department in fiscal 2003, which starts Oct. 1.

"These are quite big numbers and obviously good for defense stocks," Fothergill said.

Since the Sept. 11 attacks on the World Trade Center and Pentagon, Congress has already funded $40 billion in emergency spending for homeland defense and combating terrorism, including the costs of the war in Afghanistan.

SECTOR GAINERS

"Defense stocks rallied 6 percent to 18 percent in recent days, but then many declined with the market yesterday," wrote Byron Callan, analyst at Merrill Lynch, in a note. "The proximate cause of the rally was news that the fiscal 2003 budget would be higher than expected."

Shares of Northrop Grumman, maker of the B-2 Stealth bomber and Global Hawk spy plane used in Afghanistan, rose $4.21, or 3.9 percent, to $111.02 on the New York Stock Exchange shortly after midday.

The company, which is also the world's largest builder of warships for the U.S. Navy, posted a 50 percent increase in operating income on Wednesday, driven by strength in electronic systems and information technology, as well as acquisitions.

On Thursday morning, Deutsche Bank Alex. Brown analyst Christopher Mecray reiterated his "strong buy" rating on the stock, saying the financial results came in above target.

Mecray called Northrop's shares attractive, saying growth in 2002 should be strong and should pick up in 2003 with a possible boost from revised defense budgets.

"The results tend to confirm that Northrop Grumman is well on track to show stable and strong operating results, while growing the business through a combination of acquisition and core growth," Mecray said.

Los Angeles-based Northrop has the most expensive stock in the defense sector.

Defense communications firm L-3 follows close behind, with its stock rising $2.34, or 2.37 percent, to $101.45 on the NYSE.

L-3, which supplies communications systems to government agencies and defense contractors, reported a 43 percent increase in fourth-quarter profit, thanks to new acquisitions and strong sales of its military electronics products.

Joe Nadol, analyst with JPMorgan, said his "buy" rating on L-3's stock was based on the company's growth strategy, consistent financial performance and position in defense electronics.

"The L-3 investment story has evolved over the past two years from one heavily focused on acquisitions to one more focused on execution and internal growth," Nadol said in a research note.

"With the increased level of defense spending that is about to materialize as well as the larger size of the company, L-3 will likely be generating a higher percentage of its growth internally than it used to," Nadol said.

Among other strong gainers in the sector on Thursday, Goodrich Corp. rose 66 cents, or 2.5 percent, to $27.50, General Dynamics rose $2.66, or 3.1 percent, to $87.96 and Lockheed Martin Corp. gained $1.53, or 3.03 percent, to $51.99.

Many companies, including Lockheed and General Dynamics, were scheduled to make presentations during the day at a Bear Stearns defense conference in New York.