Defense: The Two Faces of Power

People often equate military power to enforcing your will upon an enemy.

But the concept of power is changing in military circles. Nowadays power depends on moving vehicles, support for communications systems and maintaining operations inside and outside the battle space.

The US military is the world’s largest single consumer of energy in the world. In fiscal year 2008 the Dept of Defense (DoD) spent $20 billion on energy.

DoD faces the challenge of transitioning from unreliably sourced, increasingly scarce and increasingly expensive fossil fuels to ubiquitous, easily stored electricity. And because the US military is the world’s largest energy consumer, there’s a lot of money on the line for companies that help the DoD to realize their vision.


How can investors make money as these transition progresses? Invest in companies that make unsexy things like servo motors, power supplies, controllers, generators and wires. These are pieces of equipment that are embedded in almost everything that rolls, flies, or sails. But the next generation products differ greatly from their predecessors.

Another big trend in this sector is the military’s transition to commercial off-the-shelf (COTS) components. Contracting with companies to build electronic components to military specifications is slow and expensive compared to modifying or buying ready-to-ship COTS products.

In the operational theater, it follows that creating more efficient, more powerful and more compact electronics is essential. Companies that build these devices will land more contracts than in the past.

And because many of these companies have long-standing relationships with the armed forces, their slow, steady business will grow rapidly. These stocks should perform more like tech stocks than defense stocks.

On the broader front, the military is becoming increasingly uncomfortable with the reliability of the US electrical grid. There’s a movement underway for military bases to have their own energy sources. This means developing alternative energy resources, using Smart Grids or Microgrids for bases and transitioning gas-guzzling vehicles to electric vehicles.

Ways to Play

On the component side, my favorite company is Curtiss-Wright Corp (NYSE: CW). This company has been around since the inception of flight–the Wright in the name is the Wright brothers and the Curtiss is Glen Curtiss, founder of the largest airplane manufacturer in the world in World War I.

These two forces merged in July 1929 and listed on the Big Board in August–granted, not the best timing in the world, but these guys were innovators, not bucket-shop players. Since then, the company has gone through many transformations. Today Curtiss-Wright specializes in service valves, pumps, controls and electronics that are critical to national defense programs and commercial markets such as nuclear power generation, oil and gas processing and general industry.

If you’re looking for heavy-duty, battle-tested equipment for virtually any big, nasty job out there, Curtiss-Wright has you covered. Its Motion Control and Flow Control divisions service most of its military contracts. In the first quarter operating income for these divisions was up 21 and 33 percent, respectively. And its oil, gas and coker revenues were up 37 percent.

The company is coming out of a tough environment, so the stock is still sluggish and analysts aren’t looking ahead yet. Generally, it will take a quarter or two of stronger-than-expected earnings before analysts jump on the trend. The stock is 77 percent institutionally owned, which in this kind of market means it gets slapped around until there’s a clear path to growth. It’s there now; get in before Wall Street figures it out.

This isn’t a trading position; this is a long-term investment in a company that’s strategically placed in some of the most compelling growth sectors in the military and natural resource markets. Curtiss-Wright is buy up to 35.

Vicor Corporation
(NasdaqGS: VICR) designs, develops, manufactures and markets modular power components and complete power systems. This is a small company and is coming off a heady run. The stock only has about 30 percent institutional ownership, which is good in the sense that it doesn’t get lost in a big defense/aerospace portfolio. But the stock can get caught in the maws of momentum and quant traders and get knocked around for a few points here and there.

It’s most promising product in the defense sector is its V-I Chip, which provides AC-DC conversion and 28-volt DC input in a rugged, miniature package. The military is rethinking the ground vehicle as it prepares to retire the Bradley Fighting Vehicle and replace it with a new mine-resistant armored personnel (MRAP) vehicle capable of transporting 12 soldiers. Because these vehicles can weigh in at anywhere between 20 and 70 tons, maintaining their electronics–communications, gun turrets, environmental controls, sensors, hatch doors, etc–is a big task.

On the aeronautics side, COTS is the name of the game, and Vicor’s product line is up to the task. It builds modular power converters, which are becoming popular items. The “Bricks” as they’re known are already being used on cutting-edge helicopter countermeasure systems.

With a few more decent contracts, this company becomes a takeover play for a larger, diversified military contractor looking to broaden its portfolio. M&A activity is also heating up in the industry, with the first- and second-tier defense companies looking to put some of their piles of cash to work. Vicor is a buy up to 14.

On the macro side, Cutting Edge Tech Portfolio holding American Superconductor (NasdaqGS: AMSC) is one to watch. It started life about two decades ago hoping to revolutionize electricity distribution with superconducting wires, which can transport exponentially more electricity in a wire the fraction of the size of common copper cable.

Over the years it has become one of the leading wind power companies in the world; its equipment is used to increase the efficiency of wind turbines, and it has a line of products that manage and balance the generated power so it can be reliably converted from DC to AC. Its Windtec subsidiary has a large and growing relationship with China’s second-largest wind company, Sinovel. The firm also just inked a deal with an Australian subsidiary of Vestas (Copenhagen: VWS), the world’s preeminent wind power firm. American Superconductor is well established in Europe and moving into India.

The US wind market is still fractured because of the antiquated US grid, but it’s making inroads here with its superconducting power lines for back-up and emergency systems. The business has kept the company growing nicely. (Readers looking for more information on American Superconductor’s first-quarter earnings should consult Roger’s recent article, Looking Back and Looking Ahead).


The next play for American Superconductor will be to establish itself as a major player in the conversion of military bases to their own Microgrids and a player in the Smart Grid and the US renewable energy movement.

In the meantime, it’s doing quite well gaining market share abroad, which in the long run will be very beneficial to its business model. American Superconductor is a buy below 32.

A new player in the energy storage industry that has built a better mousetrap, or in this case a better flywheel, is Beacon Power (NasdaqGS: BCON). Flywheel engines have been around since the 1950s but the new generation is much bigger and produce much more power–25 kilowatts in the case of the flywheel Beacon has build for the US Navy.

The Navy is hoping to find an energy that’s safer and more efficient than the batteries currently in use. It also would be a perfect fit if the military can perfect electronic weapons. The flywheel, or Smart Energy 25, would be used to power an electric gun, or Railgun, so that the burst of electricity wouldn’t swamp the ship’s electrical grid. It could also be used in combat situations to keeps systems alive when the ship’s generators go down.

Beacon pitched its concept to the Navy, saying its system was better than batteries because flywheels have an extremely long cycle life because they don’t use a chemical reaction to charge and discharge electricity; temperature doesn’t affect their performance, and there are no risks of chemical or thermal runaway.

The flywheel’s advantages are similar to ultracapacitors, but the size of the Smart Energy 25 and its potential to be scaled up may make them ideal for naval and stationary power storage. I like Maxwell Technologies (NasdaqGS: MXWL) in the ultracapacitor sector; it’s a buy 14.

If you’re a interested in emerging technology and want a speculative ground-floor opportunity, Beacon Power is a good choice. The Navy money it received will help it build prototypes that it can then pitch to utilities and Smart Grid developers and corporations looking for alternative energy uninterruptible power sources. Beacon Power is a buy up to 0.50.

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