New Drone Policy? 3 Ways To Play

The Obama administration recently unveiled new plans for the international export of U.S. military drones, including armed drones, to U.S. allies. As per the new policy, the export of U.S. drones will be approved on a case-by-case basis following export requests made by allied countries. And the export must essentially be made through government programs, as is the case with all weapon exports.

Allies importing the drones must abide by certain end-use assurances and agree to use them for purposes approved by the U.S. The buyers must pledge to adhere to international law and refrain from using the drones for unlawful surveillance.

Essentially, the drones can only be used for military operations that conform to international codes of conduct. The State Department would monitor the use of the drones.

The new policy amid rising demand for drones only goes on to prove how indispensable they've become to counter-terrorism. Drones can be used for surveillance as well as carrying out airstrikes, if required. The U.S. has been using drones for these purposes since 2001. In fact, the FY16 defense budget proposed by the Obama administration has also put due emphasis on intelligence, surveillance and reconnaissance ("ISR") and missile defense.

Why the Policy Change?

The shift in U.S. policy has an ulterior aim of curbing the import of drones by allied nations from other countries such as Israel and China. Both nations also manufacture exportable unmanned aerial vehicle ("UAVs"), also referred to as unmanned military aircraft.

On the other hand, increased import of U.S. UAVs by allied nations will help the U.S. to more closely monitor the application of this weapon system that has been much criticized by humanitarian groups. The very fact that the drones are unmanned reduces the threshold for opening fire against unarmed citizens.

A Boon for Defense Players

The obvious beneficiaries of the new export policy are the U.S. defense players. The defense manufacturers are struggling to keep their top lines ticking amid budget cuts at home. The export policy would open up a window of opportunity for those developing unmanned systems or building sensors and missiles for use on those systems. Notable among these companies are Raytheon Company RTN and Textron Inc. TXT.

3 Defense Stocks to Buy Now

Here we present three top-ranked defense stocks that will gain from the new policy:

Lockheed Martin Corporation LMT not only builds unmanned systems but also provides advanced radar and sensor systems for ISR capabilities. It is one of the joint developers of Hellfire missiles that are extensively used by the popular Predator and Reaper drones. Hence, the new policy will boost the demand for Hellfire missiles, adding to top-line growth.

Lockheed holds a Zacks Rank #3 (Hold) and has an expected earnings growth rate of 7.19%. Also, the stock currently looks relatively cheaper. It trades at a forward price-to-earnings (P/E) multiple of 17.73.

Northrop Grumman Corporation NOC partners Lockheed for developing Hellfire missiles. The defense pro is also involved in building unmanned systems like the popular Global Hawk.

The Global Hawk has the ability to transform itself into an operational weapons system when required. It was used by the Air Force for maintaining overseas surveillance after the Sep 11, 2001 terrorist attacks.

Northrop holds a Zacks Rank #2 (Buy) with an expected earnings growth rate of 9.22%. The stock currently trades at a forward P/E of 17.77x.

L-3 Communications Holdings, Inc. LLL provides integrated ISR solutions in addition to providing various sustainment and maintenance services for ISR systems.

This Zacks Rank #3 stock has an expected earnings growth rate of 6.31%. The stock currently trades at a forward P/E of 16.98x.

Changing Priorities

With rising security threats, the U.S. government has realized the need for ISR technologies and has shifted its emphasis toward high-tech intelligence equipment. On a global scale, the demand for weapons has witnessed a gradual turn.

Instead of guns and ammunition, we see growing demand for sensors, missiles and next-generation ISR technologies to dowse extremist outfits like ISIS. This should definitely help defense players agile enough to cater to changing demand to witness huge gains ahead.