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6 stocks that benefit from rising tensions in the South China Sea

The South China Sea conflict has largely been a case of 'failure to act' whilst the law of the sea has been flouted. China continues to exert military control over its neighbours over the hotly contested waterways, completely unabated.
Investing 101

The South China Sea conflict has largely been a case of ‘failure to act’ while the law of the sea has been flouted. China continues to try to exert military control over its neighbours with respect to the hotly contested waterways, completely unconcerned by diplomatic protests by those countries. The US has largely taken a neutral stance despite the 12 July 2016 ruling that saw an independent arbitratation tribunal established under the UN Convention on the Law of the Sea (UNCLOS) publish a clear and binding ruling on China’s claims vis-à-vis the Philippines in the South China Sea.

Enough is enough. Over the weekend the US drew a line in the sand and declared China’s territorial grab illegal, and tried to encourage its neighbours – Philippines, Vietnam, Malaysia and Brunei – to stand their ground. A US statement said: “We are making clear: Beijing’s claims to offshore resources across most of the South China Sea are completely unlawful, as is its campaign of bullying to control them.”

In response, the aircraft carriers USS Nimitz and the USS Ronald Reagan and their strike groups are already patrolling international waters in the disputed area, and the UK government has indicated that its brand-new aircraft carrier, HMS Queen Elizabeth, will be deployed to the region next year, to counter an increasingly aggressive China. Allies Japan, Australia and Canada will be invited to provide escort warships or submarines to complete the flotilla: in fact, Royal Australian Navy vessels have already joined the US Navy in “freedom of navigation” voyages through the disputed area, and have experienced first-hand the Chinese predilection for provocation. As always, everyone wants a peaceful outcome, but there is no denying that tense situations arise. In this piece however, we look at six stocks that stand to benefit from a military buildup in the South China Sea.

  • The lead-up to a conflict is usually the most volatile because of the uncertainty. But when the eventual outbreak of war occurs, share prices usually rise as the market realises that a material impact on the economy is unlikely (and that a diplomatic settlement will ensue). There are a group of stocks that are positively skewed towards war such as military equipment manufacturers and military technology companies. Here are our 6 stock picks:

    1. Austal Limited (ASX: ASB) – The Perth-based ship builder has the primary contracts to design and build two classes of combat vessels for the US Navy, at its shipyard in Alabama (Austal is the only foreign shipbuilder ever to have designed and built warships for the US Navy). Its flagship vessel is the Littoral Combat Ship (LCS), which is a high-speed, agile and multi-mission combatant that delivers superior seakeeping and performance. With an order book of $4.9 billion, a track record of timely delivery and the potential for military conflict in the South China Sea, Austal is a company that sits in prime position for a rerating.
    2. Lockheed Martin (NYSE: LMT) – Lockheed Martin is a defence, arms, security, and advanced technologies company. It is the Pentagon’s biggest contractor, having built the F-22 Raptor and F-35 Joint Strike Fighter. Lockheed Martin won $3.2 billion in contracts in June to give it a workbook of around $140 billion. The company will thrive during any military buildup.
    3. Northrop Grumman (NYSE: NOC) – Northrop Grumman ranks as one of the world’s largest weapons manufacturers and military technology providers. It is also the prime contractor for the Joint Surveillance Target Attack Radar System (Joint STARS), an advanced airborne surveillance system, and prime contractor for the B-2 stealth bomber.
    4. Boeing (NYSE : BA) – Boeing is a defence business as well as an airline manufacturer. The company designs and manufactures helicopters for the US military. Definitely a stock to watch.
    5. General Dynamics (NYSE:GD) – General Dynamics is a shipbuilder, similar to Austal, but also has a portfolio of tanks and land combat vehicles making it one of the go-to vendors for the US military. General Dynamics also has one of the largest defensce-focused IT and services businesses, giving it some revenue stability at times when the Pentagon is cutting back on equipment purchases. Going back in history, this company has assisted the US in multiple wars. While the US is spending close to $732 billion for its defence budget, this military manufacturer will benefit from a surge in military work.
    6. Raytheon Technologies (NYSE: RTX) – Raytheon is a missile-defence system builder, but also a leader in radar systems and electronic/cyber warfare counter-measures. The company has a long track record of working with the US military. Raytheon recently merged with UTX’s aerospace businesses, opening up a new market for it. As modern technology advances, Raytheon will be at the forefront of working to bring those technologies to the battlefield.

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