America's fleet of robotic drone warships, the Ghost Fleet Overlord, made headlines late last year when four of the vessels wrapped up a six-month tour in the Pacific, including autonomous port visits to Japan and Australia.
Last week, the ghost fleet was in the news again, with the announcement that it had grown with the launch of a fifth robotic warship, the Vanguard (designated OUSV 3).
Image source: Getty Images.
Ahoy, Vanguard!
The Vanguard -- built by the Australian shipbuilder Austal's U.S. subsidiary, in cooperation with American defense contractorL3Harris(NYSE: LHX) -- is the last of the Navy's prototype Unmanned Surface Vehicles (USV), and the first of a new class of large USVs.
Vanguard's predecessors -- Sea Hunter, Seahawk, Ranger, and Mariner -- were all built by privately held Gulf Craft under contract to defense contractor Leidos(NYSE: LDOS). All four are designated as medium USVs, or MUSVs.
Vanguard is different. At 205 feet from stem to stern, it barely qualifies for Navy specifications that its LUSVs should range from 200 to 300 feet in length and displace as much as 2,000 tons.
It's the largest prototype USV the Navy has built to date. LUSVs built for operational use will be even larger: big enough to carry from 16 to 32 missile launchers, allowing the Navy to spread them out across the sea according to a strategy called "distributed lethality."
The idea is to build a lot of cheaper ships, put missiles on all of them, and then spread them out to give a foe more targets to worry about.
Vanguard isn't ready for that mission just yet. The vessel doesn't appear to be armed at all, its larger size being mostly devoted to allowing the vessel to carry additional fuel, enabling longer voyages. But its deployment does put the Navy one step closer to its plan to make autonomous warships an integral part of the fleet, buying as many as eight or nine more hulls for a total investment of $2 billion or more.
Leidos or L3Harris?
So how do we invest in this plan? I see two primary ways to do it, with an option for a third. As one of the premier providers of warship combat systems, Lockheed Martin(NYSE: LMT) serves as an option for investing in just about any expansion of the Navy's fleet. But if you want to invest in the idea of autonomous warships in particular, Leidos and L3Harris are the best pure plays.
And of these latter two defense stocks, I think one sails head and shoulders above the other, in terms of giving you a better chance to profit.
Leidos | L3Harris | |
|---|---|---|
Market capitalization | $15.3 billion | $39.2 billion |
Price-to-sales ratio | 1 | 2.1 |
Trailing price-to-earnings (P/E) ratio | 105 | 26.6 |
Forward P/E | 14.8 | 15.4 |
Price-to-free-cash-flow (P/FCF) ratio | 19.2 | 23 |
Data sources: Yahoo! Finance; S&P Global Market Intelligence.
A few numbers stand out when comparing these two defense stocks. L3Harris is obviously the bigger company at more than twice Leidos' market cap (with a correspondingly higher debt load).
L3Harris is also currently priced at a discount to Leidos' triple-digit price-to-earnings ratio, with a 26.6 P/E that's almost exactly equal to the average P/E on the S&P 500 (which is 26.4).
But the only reason Leidos currently carries a much larger P/E than L3Harris does is that Leidos took a large asset impairment charge last year -- which ate up more than half the company's operating profit. Once that charge rolls off the back end, though, Leidos' P/E is going to drop right back down again.
Based on analyst forecasts for 2024 earnings, Leidos is going to start looking cheaper than L3Harris as soon as this year. In fact, when valued on free cash flow, Leidos is already cheaper than L3Harris.
And a new Navy contract that Leidos just won, to maintain and operate Ghost Fleet Overlord for the next three years, should help provide the profits to support those valuations.
On top of all that, Leidos is currently only one of two, out of the dozen or so defense companies that I follow, to meet my own fair-value test for defense stocks, by having a price-to-sales (P/S) ratio of 1 or less. (Only Huntington Ingalls, also a Navy shipbuilder, scores better with a P/S ratio of 0.9.)
To me, this makes Leidos the smarter play here. Cheaper on P/S and P/FCF already, and likely to be cheaper on P/E as well within the next 12 months, Leidos is simply the better bargain in autonomous shipbuilding.
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Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends Lockheed Martin. The Motley Fool has a disclosure policy.
