Operation Desert Storm has shoved two of America's least beloved industries - defense contractors and big oil - to the investment forefront.
While both flex a lot of power, past instances of overbillings by defense firms and price hikes by oil companies continue to rankle many average folks. Furthermore, as is the case with tobacco firms, some individuals and mutual funds avoid the stocks of these two groups on purely philosophical grounds.Wall Street analysts think the image of the defense industry has improved somewhat, while oil firms still have a long way to go.
"I firmly believe that Operation Desert Storm is leading to a dramatic reversal of the perception that the defense industry can do no right," said Wolfgang Demisch, director of research with UBS Securities Inc. "Coming after the low point of the cancellation of the much-criticized A-12 plane, the current military performance in the Gulf looks all the more impressive and I see 20 to 30 percent price appreciation of selected stocks over 18 months."
Defense stocks have been rising ever since Saddam Hussein invaded Kuwait, their upward potential expected to increase if war continues several months. But there is uncertainty, mostly due to federal budget constraints.
"Exclusive of the Persian Gulf, fundamentals of the industry haven't changed a lot, and the federal budget will still have some negative impact," said Howard Rubel, defense industry analyst with C.J. Lawrence Morgan Grenfell. "These stocks should be considered long-term holds, not a source of quick profits, for the big profits were made by investors who bought before the war broke out."
Oil company stocks haven't been as blessed as defense stocks. They rose significantly on the initial outbreak of war as oil prices jumped. They then fell back in October and have underperformed the overall market because it seemed likely there would be no major negative effect on oil supplies. The companies' tremendous fourth-quarter earnings reflected the oil price hikes of August and September.
"OPEC surprised everyone with its spare capacity, and I expect oil prices to stay in the upper teens to low 20s so long as there is any chance that supply could be negatively affected, and then decline to $15 a barrel," predicted Stephen Smith, oil analyst with Bear Stearns & Co. "At that point, OPEC will have to act, pushing the price closer to $20 again by year-end."
Also working against the oil companies is the fact that demand for their products has declined by 4 percent due to price jumps, higher gasoline taxes and recession.
"I suggest a market weighting of oil company stocks in a portfolio right now, then a gradual increase over the next three to six months as conditions in the Middle East improve and prices begin to rise again," said Eugene Nowak, oil analyst with Dean Witter Reynolds Inc.
Defense offers profitable opportunities. Both Demisch and Rubel recommend the stock of Boeing Co. as the dominant aircraft maker, which should benefit from lower oil prices after the war.
Demisch suggests stock of United Technologies and General Electric for their jet engine production. Beneficiaries of greater emphasis on strategic defense initiatives would include Rockwell International, General Motors "H," Martin Marietta, Lockheed Corp. and TRW Inc.
Meanwhile, Rubel suggests Raytheon Co. for its missile systems and its business and defense electronics, plus E-Systems for surveillance systems. A speculative choice is Northrup Corp., whose B-2 Stealth bomber program is still funded by the government and which would also benefit from an upgrade of the F-18.
Oil is trickier, with international companies preferred right now.
Nowak recommends Exxon Corp., Chevron Corp., Mobil Corp. and Texaco Inc., all four equally attractive with strong balance sheets and a small 9 percent of their assets in the Middle East. He considers Amoco Corp. and Atlantic Richfield the strongest domestic companies in terms of industry position and finances.
Smith likes Royal Dutch Petroleum as a debt-free haven in tough times, followed by Mobil, featuring good production and a clean balance sheet. His second-tier choices would be Chevron and Texaco. He gives only a "hold" and not a "buy" recommendation to domestic oil companies but considers Amoco the strongest of the lot.