Defense electronics stocks show no retreat

It may be time for the folks at the Pentagon to don their armor and hit the trenches. Cannon fire can be heard in all directions as criticism about the defense industry intensifies. There are the continuing procurement scandals, including last week's indictment of Congressman Robert Garcia (D) of New York in the Wedtech scandal.

The Reagan administration has been forced to put its controversial Central America policies - including aid to the Nicaraguan contras - on hold. The ``star wars'' defense program has come under increasing questioning, even from President-elect George Bush. And Congress and much of the American public are unhappy with the high levels of federal spending now budgeted for defense, even though the defense budget has declined now for four years in a row.

No sector of the federal budget is expected to come under more intense scrutiny next year than defense. Thus, it's hardly surprising that defense stocks in general are being avoided by a wary market. Price-to-earnings multiples have fallen off for some defense contractors.

Still, one defense sector has tended to outshine the group as a whole - defense electronics. That sector, according to some analysts, will presumably overshadow most defense stocks in the months ahead.

``There will continue to be slightly higher growth in the defense electronics sector than in defense stocks in general,'' says Phil Friedman, an analyst with Drexel Burnham Lambert. In fact, says Mr. Friedman, ``we expect 2 percent to 4 percent higher growth than for the rest of the defense sector.''

``But all the same,'' he adds with a laugh, ``that's not so signficant.''

Drexel Burnham Lambert, Friedman says, is now more heavily invested in defense electronics than in defense stocks in general. ``Through the first 10 months of this year,'' he says, ``the defense electronics sector slightly underperformed the market, rising 10 percent, versus a 13 percent increase for the Standard & Poor's 500.''

For all their relatively decent gains, however, ``defense electronics stocks are still in the trenches,'' says Byron Callan, an analyst with Prudential-Bache Securities. ``We're just not jumping on the stocks at this point in time. We continue to see significant uncertainties'' about the direction of defense spending, as well as uncertainties about the new defense leadership team in the Bush administration.''

``It's too early yet to pounce on the group as a whole,'' says Michael Lauer, a vice-president and analyst with Kidder, Peabody & Co. ``But I'm in the middle regarding the industry. The negativism about defense stocks in general, however, is creating some very good buying opportunities within the defense electronics sector.'' Mr. Lauer notes that there are more than 100 segments in the defense electronics group.

One investment house that recently bucked the caution regarding defense electronics is Oppenheimer & Co. In a report released in mid-November Oppenheimer concluded that the ``defense electronics industry presents one of the best current opportunities to capitalize on the gap'' between the perception that the defense sector is now in a sort of economic/political limbo, and the reality of the situation. ``We believe that there are still unique situations that will generate above average rewards [in the defense electronic sector],'' the firm concludes.

According to the investment firm.

The electronic component of defense products is increasing in new weapons systems.

The life of existing defense systems is being extended by upgrading their electronic components.

Electronic systems are being used as a ``force multiplier.'' In other words, as each soldier becomes more linked in to electronic systems, he or she becomes more effective as a fighting unit.

Oppenheimer is recommending a number of defense electronics firms, stressing that investors should concentrate on companies in the command, control, communications and intelligence, and electronic warfare segments of the industry. Among those that it likes are Lockheed, Loral, E-Systems, California Microwave, and Stanford Telecommunications.

Mr. Friedman of Drexel, however, chooses to recommend only one company at this time, Raytheon. The only stock in the group to outperform the market in October, he says, was E-Systems. Martin Marietta and Loral, he notes, both performed in line with the market.

Mr. Lauer, of Kidder, Peabody, also likes Raytheon, as well as Honeywell, E-Systems, and Varian Associates.

``This is just not the time for investors to go over the trenches regarding defense electronics stocks,'' says Callan at PruBache. But he does like two stocks - Logicon, a software firm in Torrance, Calif., and Litton Industries.

Indeed, caution continues to be a watchword for the investment community as a whole. For the week ended Nov. 25, the Dow Jones industrial average closed up 12.27 points, at 2,074.68.