Trump Effect: As President adds fuel to defense rally, Citi sees pause for some

In a research note to investors regarding the Defense sector, Citi analyst Jason Gursky downgraded Northrop Grumman (NOC), Huntington Ingalls (HII) and General Dynamics (GD) to Neutral saying that the stocks are reaching a fair value amid defense spending uncertainty under the new administration. FAIR VALUATION: This morning, Citi analyst Jason Gursky downgraded Northrop Grumman, Huntington Ingalls and General Dynamics to Neutral, as he believes Defense stocks are now reaching a fair value. After years with a positive bent on Defense names, the analyst acknowledged that he is now turning more neutral on the group, citing a potential disconnect in investor expectations for industry growth and potential pressure on historic business models. Gursky pointed out that he is concerned the market "expects too much, too fast" when it comes to industry growth. Additionally, he noted that their near and mid-term outlook remains challenged by budget constraints and a slow procurement process. The geopolitical environment has not significantly changed since the election, suggesting material movement from prior budget trajectories is not likely, Gursky argued. His work also shows that the Department of Defense is putting increasing pressure on contractors to innovate and control costs, which introduces more risk into the prime contractor business models as R&D and capital expenditures rise. The analyst told investors that he likes companies with relatively high levels of R&D and fixed price contracts due to higher margin potential. He reiterated a Buy rating on Harris (HRS), L3 Technologies (LLL), Lockheed Martin (LMT) and Raytheon (RTN). TRUMP'S CONGRESS ADDRESS: Citi's Gursky told investors that what Trump wants is still not exactly clear. In his speech last night, the President outlined a lot of places he would like to spend money but not many places to cut, the analyst noted, adding that this suggests that difficult choices will likely have to be made. While he assured U.S. allies that the country is ready to lead again, Trump highlighted that all partners have to meet financial obligations. During the President's address to Congress, Lockheed Martin got a shout-out for investing in the U.S. and creating new jobs. Further, Trump highlighted the lower cost of its F-35 program. Gursky expects to know more when Trump releases his "skinny budget" on March 14 in preparation for a full 2018 rollout in May/June. WHAT'S NOTABLE: Earlier in the week, The Washington Post said President Trump's federal budget will include a 10% increase in defense-related spending, or $54B, while cutting "virtually all other federal agencies" by the same amount. PRICE ACTION: In late morning trading, shares of Northrop Grumman are fractionally lower to $247, while Huntington Ingalls and General Dynamics are up 0.6% and 1.3%, respectively. "Trump Effect" is The Fly's recurring series of exclusive stories that highlight stocks that are being impacted, or are predicted to be impacted, by the comments, actions and policies of President Trump and his administration.