Investing.com -- UBS analysts believe the downside risk in U.S. defense stocks is shrinking, despite concerns surrounding government budget cuts.
"Consensus estimates have moved higher since the election despite the 40% sell-off," UBS stated, noting that the market has already priced in some combination of lower multiples and reduced estimates. "The downside potential seems increasingly smaller," they added.
The firm argues that comparisons between the current environment and Sequestration in the early 2010s—when government IT valuations collapsed—are misleading.
"We believe that the current environment is markedly different from Sequestration and do not believe a similar outcome is likely," UBS said.
The firm said that while Sequestration (a period in the early 2010’s when an effort to balance the federal deficit caused double-digit declines in Gov IT organic revenue) triggered revenue declines, today’s budget cuts under DOGE (Deficit-Oriented Government Expenditure) have been "more precise" and are targeting specific areas where major defense contractors have little exposure.
UBS also highlighted that during Sequestration, "EBITDA peak to trough was ~19%, and the EPS peak to trough was ~15%", but stocks began recovering even before earnings stabilized as the market realized the downside was less severe than initially feared. UBS feels a similar trend could unfold now.
Looking ahead, UBS sees the FY26 budget request as a potential "clearing event" for defense stocks, as it will provide better visibility into long-term spending plans.
While the firm expects some estimates to be revised lower, it believes this could help valuations trend back toward parity with the broader market.
"We see a FY26 budget request clearing event resulting in the current discount to the S&P 500 trending back toward parity," UBS noted. However, it cautioned that "choppy 1Q bookings could still pressure stocks before that happens."
L3Harris Technologies (NYSE: LHX ) (+1.1%), Lockheed Martin (NYSE: LMT ) (+0.3%), Northrop Grumman (NYSE: NOC ) (+1.7%), and General Dynamics (NYSE: GD ) (+0.5%) are all trading higher so far in Thursday’s session.