Shares in defense firms rising to record highs as military conflicts escalate

Led by Lockheed Martin, the biggest U.S. defense companies are trading at record prices as shareholders reap rewards from escalating military conflicts around the world.

Investors see rising sales for makers of missiles, drones and other weapons as the U.S. hits Islamic State fighters in Syria and Iraq, said Jack Ablin, chief investment officer at Chicago-based BMO Private Bank. President Barack Obama approved open-ended airstrikes this month while ruling out ground combat.

“As we ramp up our military muscle in the Mideast, there’s a sense that demand for military equipment and weaponry will likely rise,” said Ablin, who oversees $66 billion including Northrop Grumman and Boeing shares. “To the extent we can shift away from relying on troops and rely more heavily on equipment – that could present an opportunity.”

Bombardments of Islamic State strongholds added to tensions this year that include U.S.-led sanctions on Russia for backing Ukrainian rebels and China’s feuds with neighbors over disputed South China Sea islands. The U.S. also is the biggest foreign military supplier to Israel, which waged a 50-day offensive against the Hamas Islamic movement in the Gaza Strip.

A Bloomberg Intelligence gauge of the four largest Pentagon contractors – excluding Boeing, whose civilian airplanes business is larger than its military unit – rose 19 percent this year through Thursday, outstripping the 2.2 percent gain for the Standard & Poor’s 500 Industrials Index.

Lockheed, the world’s biggest defense company, reached an all-time high of $180.74 on Sept. 19, when Northrop, Raytheon and General Dynamics also set records. That quartet and Chicago-based Boeing accounted for about $105 billion in federal contract orders last year, according to data compiled by Bloomberg Government. Shares in all five fell Thursday amid the broader market decline.

“The run-up reflects what I’d say is uncertainty in the Mideast, uncertainty in Eastern Europe and uncertainty in regions of the Pacific,” said Howard Rubel, a New York-based analyst with Jefferies.

For defense companies, the offensive against Islamic State and al-Qaida extremists is more than a showcase for big-ticket weapons such as Lockheed’s F-22 Raptor fighter, the stealth jet that debuted in combat this week.

In its first night of airstrikes into Syria, the U.S. dropped about 200 munitions and launched 47 Raytheon-made Tomahawk cruise missiles, according to U.S. Central Command. The military also deployed Boeing’s GBU-32 Joint Direct Attack Munitions and Hellfire missiles from Bethesda, Md.-based Lockheed, creating an opening for restocking U.S. arsenals.

The Pentagon recently authorized Waltham, Mass.- based Raytheon to resume assembling warheads designed to intercept intercontinental ballistic missiles, a defense against threats from countries including North Korea and Iran. The program had been suspended in 2010 after failed test launches.

Global conflicts are benefiting more than just the makers of offensive weapons, according to Rubel. He has a buy rating on DigitalGlobe Inc., a Longmont, Colo.-based company specializing in high-resolution satellite imagery that has supplied equipment used by NATO to monitor Russian movements along the Ukraine border.

Pentagon contractors have been responding to the pullback in U.S. military budgets by shifting focus to international markets, said Philip Finnegan, director of corporate analysis at Teal Group, a Fairfax, Va.-based consultant that tracks defense and aerospace companies.

Even with revenue at Lockheed, Raytheon, General Dynamics and Falls Church, Va.-based Northrop down 4 percent since 2011, non-U.S. sales have climbed 9 percent during that stretch. The four companies also have pared expenses, including reducing their combined workforce since 2011 by 23,000 people, or about 6 percent, according to data compiled by Bloomberg.

The improvements to profitability, combined with investor-friendly moves such as stock buybacks, may influence share prices more than the strife in Iraq and Syria, Finnegan said.

“Clearly the world has become increasingly unstable. The question of whether that has a major impact on the defense budget is uncertain,” Finnegan said. “There may be an investor psychology that suggests that there’s going to be a large benefit to these companies. But the jury is still out.”