Defense stocks face increasingly negative sentiment from the analyst community as the industry struggles with declining global defense spending. At the same time, the best stocks in the aerospace and defense sector have a proven track record of steady dividend growth. Dividend increases are possible because defense companies still generate significant free cash flow, even though their revenue is not growing at high rates.
Despite the uncertainty of contracting defense budgets, aerospace and defense stocks performed well for the most part over the past year. In addition, these five aerospace and defense stocks pay solid dividends to shareholders and raise their dividends regularly.
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For example, in September, Lockheed Martin raised its dividend by 10% to $6.60 per share annualized. The stock now provides investors with a 3.2% yield, near the top of its sector. On top of that, the company also announced an additional $3 billion stock buyback authorization at that time.
Its strict cost controls allow Lockheed Martin to produce high amounts of free cash flow, which then lead to robust dividend growth and stock repurchases, even though headline revenue and earnings are not growing. For example, Lockheed Martin generated $4.1 billion of free cash flow in 2015, up 35% from the previous year. Its dividend cost the company $1.9 billion last year, which comes out to a comfortable 46% free cash flow payout ratio. Since the dividend represents less than half of free cash flow, there is plenty of free cash flow left to raise the dividend going forward.
Boeing (BA ) has shifted its focus from defense to commercial aircraft manufacturing. This shift in focus could pay off as the commercial aircraft market is booming. Boeing’s commercial aircraft deliveries rose 5% in 2015 and hit a record for the company. The company grew revenue by 6% last year and generated $6.9 billion of free cash flow in 2015, up 4% year over year. Its strong free cash flow generation allows the company to reward shareholders with compelling cash returns. In December, Boeing announced a 20% dividend hike, as well as a new $14 billion stock buyback program. The stock currently yields 3.3%.
Future dividend growth is likely since the company maintains a large backlog of future orders. Boeing ended 2015 with a $489 billion backlog, including $83 billion of net orders during the year.
Raytheon’s (RTN ) full-year revenue and adjusted earnings per share rose 2% and 0.4%, respectively, year over year. Revenue rose thanks to strong bookings throughout the year. Raytheon is a strong cash generator and returns cash to investors through both stock buybacks and dividends. The company repurchased $1 billion of its own stock last year, and in November approved a new $2 billion share repurchase authorization.
In addition, on March 24 the company raised its dividend by 9%. This is the 12th consecutive year of dividend increases for Raytheon. Its new annualized dividend comes out to $2.93 per share, which provides a 2.3% yield based on the stock’s most recent closing price.
General Dynamics (GD ) is vulnerable to declines in global defense spending because it generates approximately 72% of its annual revenue from government defense budgets. Because of this, General Dynamics’ revenue rose just 2% in 2015. Fortunately, the company continues to generate very healthy levels of free cash flow and maintains a strong balance. General Dynamics generated $1.9 billion of free cash flow in 2015. Its dividend payments represented 45% of its free cash flow—less than half, which is positive for future dividend growth.
Moreover, General Dynamics has a strong balance sheet. At the end of last year, it held $2.7 billion in cash and equivalents, along with a modest long-term debt to shareholders equity ratio of 27%. Further, General Dynamics recently announced a 10% dividend increase. The new dividend rate going forward will be $3.04 per share, which equates to a 2.2% dividend yield.
Northrop Grumman’s (NOC ) 2015 sales declined 1% from the prior year, but diluted EPS rose 7% thanks to more than $3 billion in stock buybacks conducted during the year. The company generates a lot of free cash flow—$1.9 billion last year alone—which allows the company to return cash to shareholders.
At the midpoint of its 2016 guidance, Northrop Grumman expects earnings per share of $10.05; this is almost three times the company’s dividend rate. Northrop Grumman’s $3.20 per share annual dividend provides a 1.6% dividend yield. That is a below-average yield, but the stock makes up for this with very high dividend growth. Over the past five years, Northrop Grumman has increased its dividend by 13% compounded annually. It has been four quarters since Northrop Grumman’s last dividend increase. Due to its low payout ratio, it is likely that the company will raise its dividend in time for its next payout, which could be an upside catalyst.
The Bottom Line
It might seem counter-intuitive for defense stocks to raise dividends in a difficult climate and also to announce large share buybacks. But these five stocks are still highly profitable with strong balance sheets. This allows them to keep increasing dividends in the years ahead.