It’s a tough time to go bargain hunting on Wall Street.
An impressive second-half rally in 2020 has many stocks trading near record-high valuations, and many of the stocks that aren’t flying high are down for a reason. Either they are in industries that have run into headwinds, or they face company-specific issues.
There are times when the market gets it wrong, and certain stocks appear to be on sale. Here’s why three Fools believe Raytheon Technologies (NYSE:RTX), Magna International (TSX:MG) (NYSE:MGA) and Huntington Ingalls Industries (NYSE:HII) are good bargains heading into 2021.
Image source: Getty Images.
The pandemic won’t hold this aerospace titan back forever
Lou Whiteman (Raytheon): Raytheon Technologies was formed less than a year ago via the merger of defense contractor Raytheon and commercial aerospace stalwart United Technologies. Management sold the transaction at the time as a way to diversify the business and shield against downturns in either aviation or defense, and that argument was put to the test quickly.
The COVID-19 pandemic devastated aviation, and caused demand for Raytheon Technologies-made Pratt & Whitney engines and Collins interior products to nosedive. Earnings plummeted, and the stock finished down 24% for the year.
The issues are real, but they are temporary. Aviation will eventually come back post-pandemic, and when it does Raytheon has a portfolio of products that will be in high demand. The defense side of the business is one of the primary suppliers of missiles and electronics to the Pentagon, and boasts a backlog of $70 billion in future orders.
Raytheon also continues to streamline post-merger, and will get a big cash boost from selling its Forcepoint cybersecurity unit. The company, despite its potential, is trading at less than one times sales and at about 13 times earnings, a discount to other defense primes.
RTX vs. defense data by YCharts
My only hesitation about recommending Raytheon right now is that given the extent of the issues facing aviation and uncertainty about Washington gridlock, it could take until 2022 to really see Raytheon shares take off. But investors who buy in now will be compensated for their patience by a 2.7% dividend yield that the company should have no problem maintaining, given its ability to generate cash.
Raytheon Technologies shares won’t remain this inexpensive for long.
A better way to invest in the electric-vehicle boom
John Rosevear (Magna International): Unless you’ve been living off the grid for the last year, you probably know that electric vehicle stocks have been about as hot as hot stocks get for several months now. So why am I recommending an old-guard auto supplier?
The answer is that Magna — a well-run business that happens to be a legacy “Tier 1” auto supplier — is rapidly transforming itself into an electric vehicle company. But the market hasn’t quite caught on yet.
For starters, Magna is moving aggressively to make its contract-manufacturing unit, Magna Steyr, the third-party manufacturer of choice for start-ups and legacy automakers moving into electric vehicles. Leveraging what it has learned from building Jaguar’s electric I-Pace under contract, Magna Steyr successfully won the bid to build Fisker‘s (NYSE:FSR) electric Ocean SUV.
Magna is working to become the contract manufacturer of choice for emerging electric vehicle companies. It recently won the contract to build Fisker’s Ocean SUV. Image source: Fisker.
There will be many more, but that’s not all. Magna has also been involved in self-driving development efforts for several years now; it’s working with Fisker on an advanced driver-assist system for the Ocean; and it’s pushing into other advanced auto technologies both on its own and with its extensive network of partners and customers.
But is Magna stock cheap? Even if we factor out the impact of the COVID-19 pandemic by going back a year, it’s still trading at about 12.9 times its 2019 earnings. Old-school auto investors might think that’s a bit rich for an auto supplier, but look it this way: It’s arguably cheap — quite cheap — for a profitable, well-run company that is already becoming a major player in electric and self-driving vehicles.
The only cheap defense stock in this overheated market
Rich Smith (Huntington Ingalls): I write mostly about defense stocks, so when you ask me to name a “cheap stock to buy in 2021,” my initial response is, “A cheap defense stock you mean? Good luck finding one!”
For the longest time, you see, it’s been hard to find anything cheap in the defense industry. But if there’s one good thing to come out of the 2020 pandemic, it’s that after giving the stock market a serious shakeup early in the year, some stocks came rocketing back — but other stocks didn’t, and still remain bargains. Surveying the defense industry today, it’s not hard to find that diamond in the rough: Huntington Ingalls is the only cheap defense stock in the industry.
Out of the seven big defense stocks that I follow, Huntington Ingalls is the only one to pass my standard screen for value in defense stocks, that they must sell below the historical average valuation for the sector — one times annual sales. At its current P/S ratio of just 0.75, Huntington’s stock is one-third cheaper than the next-cheapest defense stock (which is General Dynamics, if you’re curious). It sells for half the valuation of Lockheed Martin, and barely one-third the cost of L3Harris Technologies.
That’s my main reason for being attracted to Huntington Ingalls stock, but of course it’s not my only reason. As one of the nation’s two biggest military shipbuilders (the other is General Dynamics, by the way — the second-cheapest defense stock on my list), Huntington Ingalls stands at the center of a declared Pentagon policy to build a 355-ship navy.
Unless the Biden Administration pulls a 180 on that, this policy promises to produce years, if not decades of revenue growth for Huntington Ingalls as the U.S. battle fleet grows 20% from its current size of just 297 ships — adding a new class of ballistic missile submarines and a brand-new frigate class, and expanding its efforts in developing new remotely operated warships.
Huntington Ingalls is the perfect stock to profit from this policy, and the fact that it’s also the cheapest stock in the defense industry makes it the obvious choice for investors who want to invest in defense.
