There’s a general understanding among most financial analysts that defense companies provide significant portfolio stability during recessions. Indeed, these companies, especially defense companies with no commercial exposure, dip directly into the coffers of their countries’ governments.
Thus, they are less subject to rising inflation costs and falling consumer spending. However, these bullish perceptions evaporate with significant changes in government, leading to overvalued defense stocks to sell before election cycles.
This risk is especially pertinent when considering the upcoming Uinted States presidential and congressional elections in this November. The Democratic party holds the Senate and the presidency and has passed colossal defense spending bills for Ukraine and Israel.
Such generous spending has engorged several defense contractors who are part of a complicated web of government funding, spending and manufacturing. Therefore, investors should take a deeper look at the revenue streams of these three companies to determine if their valuations are justified.
RTX Corporation (RTX)
A favorite among institutional investors, RTX Corporation (NYSE:RTX) has seen stunning returns since conflict resurged in the Middle East. A rebrand of Raytheon Technologies, RTX maintains distinct business units via its three subsidiaries, Collins Aerospace, Pratt & Whitney and Raytheon. This results in a defense corporation whose revenue incomes are partially exposed to commercial market trends, but buffered by defense spending.
Bearing this in mind, RTX could take a stock value hit by the end of the year for two reasons. The first is the potential for a Republican-controlled Senate, which could cut funding for Ukraine. Furthermore, should Donald Trump secure another term, he openly intends to end the wars in Israel and Ukraine expediently.
Two of RTX’s major programs include $1.7 billion in Patriot missiles for NATO and Israel and $282 million for air defense systems for Ukraine.
This demonstrates that a change in government policy could cut deep into RTX’s booked revenues and impact future performance.
Thales Group (THLLY)
Late last year, the Thales Group (OTCMKTS:THLLY) found its Glasgow, Scotland-based factory under attack by Palestinian activists. The result was approximately 1.5 million British pounds of damages to factory equipment and machinery. While the damages did little to impact Thales’ bottom line, it underscores Thales’ involvement in weapons development with its Israeli partner, Elbit Systems (NASDAQ:ESLT). Together, the two companies co-develop the Watchkeeper drone, which has seen extensive use as a monitoring platform in places like Iraq and Afghanistan.
For Thales, this relationship is one of its many international partnerships that rely on spending from the United States. That’s because Thales operates primarily as a European conglomerate and receives funding through American expenditures for supporting NATO and Israel. This structure could prove problematic after this year’s election cycle for one major reason — a Trump presidency.
During Trump’s first term, he openly worked toward budget cuts to NATO spending. Should he return to the presidency, this rhetoric could resume, impacting international defense companies like Thales.
Leonardo DRS (DRS)
As a subsidiary of an international conglomerate, Leonardo DRS (NASDAQ:DRS) faces the same potential political challenges as Thales. DRS has been a critical provider of onboard electronics for the F-35 and several U.S. military programs for decades. Up 47% in the last year, the stock has won major defense contracts that have extensively boosted growth.
Chief among these is its $3 billion contract to support the electric propulsion systems of the U.S. Navy’s new Columbia-class submarines. This contract will support 12 such ships for the next three decades. The project will be a priority as the Navy replaces its aging Ohio-class nuclear ballistic missile submarines.
However, the Navy tends to cut short such procurement programs. Take, for example, the cancellation of the Zumwalt-class destroyers and Seawolf submarines over the last 30 years. Thus, DRS could become one of those overvalued defense stocks to sell in the event of cost-cutting measures should the Columbia-class submarines prove too expensive.
On the date of publication, Viktor Zarev did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.