The aerospace and defense (A&D) industry may be entering a period of sustained growth, as governments around the world increase military spending in response to rising geopolitical tensions. After years of relatively limited investment, defense budgets are expanding, creating opportunities for companies positioned to benefit from the next wave of military modernization.
But the opportunity extends beyond traditional defense contractors. Conflicts in Ukraine and the Middle East have demonstrated the growing importance of unmanned aircraft, autonomous systems, advanced missile defenses, and next-generation propulsion technologies. As military priorities evolve, companies developing these capabilities could capture a growing share of defense spending in the years ahead.
Against this backdrop, Macquarie analyst Marni Lysaght believes investors should look closely at companies with the right capabilities to capitalize on the industry's long-term prospects.
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"We view A&D as being in the early stages of a multi-year investment cycle, supported by accelerating sovereign defense spending following a prolonged period of relatively constrained investment. This spend is not limited to traditional defense programs. Recent conflicts, including Russia-Ukraine and with Iran this year, have highlighted the increasing role of autonomous systems and drone warfare, the latter concerning both unmanned aerial systems (UAS) and counter-UAS (C-UAS)… Beyond attractive end-market exposure, we believe our newly initiated companies exhibit a range of differentiated company-specific attributes that position them well within the current operating environment and underpin our positive investment thesis," Lysaght writes.
The Macquarie analyst doesn't stop there. She's put her money where her mouth is, and recommended two defense stocks that she sees with 70%-plus upside in the coming year. Let's give her choices a closer look, using the latest info drawn from the TipRanks data platform .
AeroVironment ( AVAV )
First up is AeroVironment, an aerospace company that specializes in drone technology and is an important supplier to the Pentagon. In fact, AeroVironment is based in Arlington, Virginia – in close proximity to the Pentagon, and that proximity is not a coincidence. AeroVironment, also known as AV, is a leading developer of uncrewed systems for land, sea, and space applications, and its autonomous systems are used in loitering munitions, counter-UAS technologies, and even directed energy applications.
AeroVironment has been in operation since 1971, and has built a deep reputation in the drone field. The company's role has grown more important with the expansion of drone use since the 1990s, and its uncrewed systems are capable of meeting the common unpredictable contingencies of the military world. The company's product lines include a wide range of man-portable flying drones, one-way attack drones, loitering munition systems, and high-altitude pseudo-satellites. In addition, AV has lines of unmanned ground and maritime vehicles. All of these drone systems allow troops to conduct reconnaissance and/or surveillance, and even to deploy firepower for both offensive and defensive purposes.
In addition to its uncrewed system lines, AV provides training and support services for the military, to ensure that the boots on the ground can make proper and efficient use of the systems they deploy.
AeroVironment acquired BlueHalo last year, a drone tech firm, in a transaction that came to $4.1 billion. The merger brought AV a new branding, along with a new portfolio of unmanned air and ground vehicles, and an expanded reach in its uncrewed space vehicles. In recent weeks, AeroVironment's new BlueHalo unit has secured a US Air Force R&D contract worth up to $99.8 million. The contract is to support military space systems.
Earlier in September, the company announced a milestone in its directed energy counter‑drone capabilities, with the first purchase order for its LOCUST Laser Weapon System. The purchase order is a first under the direct commercial sale category, and is valued at more than $50 million.
The company's last financial release covered fiscal 1Q27. Revenue in that quarter came to $480.5 million, $24.4 million better than had been anticipated and was nearly 6% better than in the prior-year period. The bottom line, at $0.59, was up from $0.32 and beat the forecast by 34 cents. The company's funded backlog, at $1.5 billion, was a record, and was up 37% year-over-year.
Once again, we'll look at the Macquarie view, as set out by analyst Lysaght, who is impressed by the company's innovative history and commitment to solid research and development funding. She says of the company, "We see AeroVironment being supported by sustained investment in innovation, with the company currently focused on R&D levels at 7-9% of revenue, ahead of peers in the ~3-4% range, enabling rapid product development and prescient investment ahead of evolving customer requirements… Ongoing investments in manufacturing capacity are also enabling sustained production growth, whilst also lowering bottlenecks and ultimately positioning the company to meet customer demand as programs scale. With its participation in emerging initiatives such as Golden Dome through AV Halo_Shield and its diversified product portfolio in addition to a relatively modest gearing profile, which supports capacity for further inorganic growth, we believe AVAV is well positioned to benefit from the current defense spending cycle."
Looking forward for AeroVironment, Lysaght puts an Outperform (i.e., Buy) rating on the stock, a rating that she complements with a $210 price target. That price target suggests the stock will gain 72% by this time next year. (To watch Lysaght's track record, click here )
The 17 recent analyst reviews here include 13 Buys to 4 Holds, for a Strong Buy consensus rating. The stock's $121.79 trading price and $214.88 average target price together imply a 76% gain on the one-year horizon. (See AVAV stock forecast )
Kratos Defense ( KTOS )
The next Macquarie pick we'll look at is Kratos, a San Diego-based defense firm with a focus on new and emerging defense-related tech, in areas such as advanced propulsion and power systems, hypersonics, space technology, microwave and digital solutions, new weaponry, and unmanned systems. Kratos offers its customers in the US and Western-allied national security communities a series of platforms and systems designed from the ground up to make use of these new technologies, in both defense and civilian/commercial security applications.
Kratos has recently had some important updates on some of its programs, just this month. On October 12, the company, in conjunction with Airbus, announced the successful first flight of the U740-Valkyrie, the Europeanized version of the US Air Force's XQ-58 program. This aircraft is a semi-stealth armed drone, designed as a 'loyal wingman' for combat missions in contested airspace.
Also on October 12, the company announced important advances in its J85 turbojet program. These include successful flight tests in multiple configurations, including lugged launch, palletized, and surface-to-surface applications. The J85 is designed to be highly flexible with high performance, allowing for start-up at altitude, reliability, and efficiency, leading to longer mission time and range, and a high probability of success. The engine is intended for low-cost cruise missiles, decoys, and unmanned aerial systems.
And finally, on October 14, Kratos broke ground on new projects in Indiana for facilities related to the new Helios and AN/SPY-1 projects. The facilities have funding from the Pentagon, the Department of War's Industrial Base Analysis and Sustainment. The Helios facility will focus on the next generation of directed energy weapons, while the AN/SPY-1 facility will work on repair, testing, integration, and sustainment of a major US Navy radar system.
When we turn to finances, we find that Kratos reported $458.8 million for the second quarter of this year, a total that was $47.6 million better than expected and was up more than 30% year-over-year. The company's bottom line, reported as a non-GAAP EPS of
For Macquarie's Marni Lysaght, the variety of programs gives Kratos a sound outlook in the industry. She writes, "We believe Kratos' position across multiple customer channels provides diversification and allows it to participate in defense modernization through a variety of procurement pathways. Unlike AeroVironment, which has used M&A to address capability gaps and broaden exposure, Kratos has primarily focused on organic development, reflecting the breadth of its existing technology portfolio and limited need for transformational acquisitions. We also see Kratos as a beneficiary of the current replenishment cycle for missiles and munitions, with governments increasingly focused on expanding production capacity and rebuilding depleted inventories. Combined with zero debt, continued investment in innovation and exposure to structurally growing end markets, we believe Kratos is well positioned to benefit from the current defense spending cycle."
These comments support a clear Outperform (i.e., Buy) rating, and Lysaght gives the stock a $70 price target that points toward a one-year upside potential of 73%.
Overall, Kratos gets a Strong Buy consensus from the analysts on Wall Street, based on 19 recent reviews with an 18-to-1 split in favor of Buy over Hold. The shares are trading for $40.42, and the $92.72 average target price is even more bullish than Macquarie allows, suggesting a robust 129% upside in the next 12 months. (See KTOS stock forecast )
Disclaimer: The opinions expressed in this article are solely those of the featured analysts. The content is intended to be used for informational purposes only. It is very important to do your own analysis before making any investment.
