CORRECTED – BUY OR SELL-Which defense firms will get lift from budget?

(Corrects last name to McCarthy from Murphy in eighth
paragraph)

* Modest increase seen for US defense spending

* Specialty technologies seen as winners

* Big companies face slower growth

By Karen Jacobs

ATLANTA, Feb 3 (BestGrowthStock) – Will expected increases in U.S.
defense spending lift all contractors over the next year?

On Monday, U.S. President Barack Obama asked Congress to
approve $708 billion in defense spending for fiscal 2011,
including a 3.4 percent rise in the Pentagon’s base budget plus
billions more to fund U.S. military operations in Iraq,
Afghanistan and Pakistan. [ID:nN01203835]

Defense stocks, which have been clouded by concerns that
growth in U.S. spending will slow in coming years, headed lower
on Wednesday after two straight days of gains. The Standard &
Poor’s Aerospace & Defense Index (.GSPAERO: ) was off a modest
0.2 percent in afternoon trading.

Analysts say niche companies will benefit more than others
as the Obama administration seeks to fight new enemy threats
while traditional weapons programs face more scrutiny.

BUY SPECIALTY

Small companies that provide next-generation systems and
upgrades for unmanned systems and products that gather or
monitor intelligence are poised for success, said Michael
Ciarmoli, an aerospace and defense analyst with Boenning &
Scattergood.

“That portion of the budget seems to be insulated,”
Ciarmoli said. “Seemingly, these companies are in the sweet
spot.”

His top picks for 2010 include Comtech Telecommunications
(CMTL.O: ), a provider of mission-critical tracking networks,
satellite company Orbital Sciences (ORB.N: ) and FLIR Systems
(FLIR.O: ), which makes cameras used in unmanned spy planes.

Patrick McCarthy, an analyst with FBR Capital Markets, said
the latest budget request provided upside for so-called “Army
plays,” prime contractors such as missile maker Raytheon Co
(RTN.N: ) and L-3 Communications (LLL.N: ), which provides products
that detect explosives.

“With this budget, the Obama administration and (Department
of Defense) are clearly recognizing that defense spending needs
to stay high,” Murphy said.

SLOWER GROWTH FOR SOME BIG PLAYERS

Companies in FBR’s coverage space that fared the worst
because of the budget were industry leader Lockheed Martin Corp
(LMT.N: ) and AeroVironment (AVAV.O: ), the firm said.

Peter Arment, an analyst with Broadpoint AmTech, said
growth would slow for some big contractors because of a flat
outlook for weapons-modernization spending.

Broadpoint AmTech maintained a “buy” on Raytheon, but said
it was still on the sidelines for General Dynamics (GD.N: ) and
Lockheed, which faces pressure over its F-35 Joint Strike
Fighter, the world’s largest military aircraft program.

This week, U.S. Defense Secretary Robert Gates said that he
would dock Lockheed $614 million in performance fees because
the F-35 program’s performance had not met expectations over
the past two years. Gates also replaced the Pentagon’s manager
in charge of the program.

“Lockheed is highly respected and we certainly think its
valuation is very cheap,” Arment said. But, he added, “The JSF
has slipped in terms of timing and we’re not seeing the
earnings progression that we’d like to see.”

Investment Research

(Reporting by Karen Jacobs; editing by Robert MacMillan)

CORRECTED – BUY OR SELL-Which defense firms will get lift from budget?