Wall Street Week with Louis Rukeyser; 2316; Defense Stocks under Clinton

It. From. All. Over. The. World. Or. Wall Street Week With Louis Rukeyser is made possible by the Corporation for Public Broadcasting. And by the annual financial support from viewers like you by the travelers over 30 million Americans benefit from our insurance investment services and managed health care. The travelers America's umbrella by MFX and FS helping mutual fund and institutional investors achieve their financial goals. Since 1924 and by Prudential Securities we believe the most important thing we earn is your trust.

Prudential Securities. Produced Friday October 15. Our panelists are Alan Bond Harbi Isen and Carter Randol. Tonight's special guest is Philip Freedman managing director Morgan Stanley and Company. Good evening. I'm Louis Rukeyser. This is Wall Street Week. Welcome back. Well this is the weekend that the World Series begins and the world of money where the games have long since begun was as full of surprises as the Philadelphia Phillies. The Bell Atlantic corporation and telecommunications Incorporated announced the biggest media merger in history confirming that all that Buck Rogers ish so-called interactive technology we've been showing you this year may not be just some salesman's pipe dream after all. Wall Street reacted to the news with its customary discernment rushing

wildly to buy shares in any company that had the name telephone or cable even vaguely in its job description. And throughout the world of business amazing turnarounds were it. Apple computers legendary chairman John Sculley resigned for example and those sentimental fools and Wall Street dried their tears long enough to send the stock up nearly 20 percent in a single day. Apparently reason and if that is the word that good earnings were worth more than goodbye's adding to the how quickly they forget department was electronic data systems the company Ross Perot built and with what it was associated until 1986 which apparently closely studied its X-boxes latest economic pronouncements and concluded that to put it gently they didn't exactly compute. So edX took out full page ads to explain that whatever Perot may be saying

to the contrary and I quote Nafa is right for America and after it is right for the United States. Why Ross hasn't been treated with that much contempt since the last time he served on a corporate board of directors at General Motors. And speaking of 180 degree turnarounds some leaders of the computer industry which this time last year was pleading for all kinds of government intervention on its behalf. Went to Capitol Hill to beg Washington to leave the industry alone. As Cyrix CEO Jerry Rogers put it and I respectfully quote Despite the good intentions of government policies and institutions their participation actually hinders progress in this industry. Now by golly day who would have thunk it. Meanwhile there was a turnaround of sorts at the top of us foreign policy where one time isolationists who shunned American involvement to combat communists in Southeast Asia we're now making or contemplating policy initiatives from

Somalia to Bosnia to Haiti where President Clinton ordered six U.S. warships to enforce the United Nations trade embargo apparently hoping that this time limited U.S. intervention would work and the American forces would be able to leave Haiti for a change. Hearing some song other than the sadly familiar do do that voodoo that you do so well. None of these turnaround tunes could spoil the party on Wall Street traders ignore the occasional sign that the U.S. economy might not actually be expiring such as the sixth straight monthly improvement in retail sales and instead focused on the virtual absence of inflation on either retail or wholesale levels to send the yield on the 30 year Treasury bond to the lowest level ever below five point eight percent. And to carry this enthusiasm over into the stock market where most major averages finished at record highs. We tonight will put it all together in the time that

somebody did by talking with a financial whiz who also happens to be the reigning champ on the defense industry which practically everybody hates until they actually need to use its products. Somewhere on this still trouble globe. But first let's see who was coming to bat in Wall Street. The Dow Jones industrial average this week had the dubious distinction of being the only major index that didn't set a record. But in the heaviest trading since February even in this year of unprecedented volume the Dow wound up only 23 points short of a new peak up another 45 points running. That's four weeks straight to 116 to close at 36 twenty nine point seventy three. And every number you see here is a record as a new york and S&P louer chip composite joined the parade led by the secondary indexes in the no surprise category 10 chief elves remained immobile for the 21st

straight week at a still bullish plus three in the happy surprise category. The U.S. trade deficit narrowed thanks to a new surge in American exports and the dollar strengthened. Gold proved to any remaining doubters that its current fluctuations have no connection with any genuine inflation threat. Supply and demand buyers push the metal up five bucks an ounce in a week when the inflation indicators submarine. But don't relax yet. It now appears that we have something new to worry about on the inflation front. Not only are the effects of the Midwestern flood likely to be felt later this fall and food prices from corn to cabbage but floods and rains are sending pumpkin prices higher too. And just before Halloween jack a cardboard anybody got a medal every time we're told that interest rates have gone about as low as they can go to go lower. How come. Well you already said it Lou inflation is dormant at the moment and that's why interest rates come down.

But I frankly have come down further than I thought they would. The short rates have been on change for a long time long rates have come down pretty dramatically. 5.8 percent or wherever. I think inflation is going to come back up not rapidly not to high levels but come back up and interest rates with it and interest rates with it come a little growth in the economy in 1994. So I think we've had it as the stock market overextended. No. I think a fair value in the market on the Dow Jones industrial average is somewhere between 30 740000 depending on whether you're using this year's earnings of next year's earnings. And I'm much more inclined to use next year's earnings. So I think there's still a play in the market. I really do. Because the current favorites Lou some of the same and some different I think some of the cyclical stocks the housing autos still will do well. I think some of the depressed stocks such as

UTX technology the old Waste Management WM makes or do well. I mean Carter just alluded to the autos. Chrysler gave the market a happy surprise. Speaking of turnarounds and it did very well the other auto stocks for the long. What do you make of these cyclical stocks the economy in better shape than we think. Well when you talk to the economists things are bad and when you look at the car figures things are good. The economy I think is definitely in better shape but I think the answer is you have to take it sector by sector when you make these gross generalizations you wind up being wrong. Well that makes some non-road generalizations for us. Well I think what you pointed out I mean I think there's an absolute revolution going on in the telecommunications media interactive and there are so many significant investment consequences of this that I think this is something that's going to be with us for a long time. You still see in this. Oh absolutely. I mean it's like every day I watch Aladdin because my kids watch it and they stick me in front of it. Here's a film

that grossed $200 million at the box office in the first week of video sales sold more than 200 million videos of Disney which is a stock it's almost unchanged this year because they had a couple of quarters and they have problems in Euro Disney I think is an absolute steal longer term not a Mickey Mouse investment. It may be that Alan Bond What do you like these days. Lou I like the market. I think we saw an interesting resurgence this week in the consumer non-durable sector. The market led by companies like Kellogg also companies like General Mills. I think the reason we see it we saw that activity was because of the fact that these are multinational growth companies and that the overseas business for these companies could be improving. So I think that it looks that bodes well for the market. As you mentioned also with great earnings reports from companies like Chrysler. Also Texas Instruments and bodes very well for the stock market open correctly positive win win many faded. You also have been a fan over the years of some of those those great and now faltering growth stocks some of them seem to be perking up a little bit. You see much signs of life there.

And do see signs of life there and I think that that that has occurred because of the strategic alliances like we saw as you talked about with Bell Atlantic. I think we will continue to see this merger wave of activity and with debt consolidation a lot of the growth stocks will benefit because these companies have been undervalued for some time. All right. In any event Pao's It's time now to keep setting some records for our viewers. Colorado Martin Harris of San Francisco wonders why he doesn't hear more about preferred stocks with everybody clamoring for higher yields. He writes shouldn't preferred stocks be very desirable. No not for individual investors absolutely not. That is too high a degree of risk of risk on the downside and the price is enormous. If interest rates go back up again because you you own perpetual maturity fixed income investments for them where you can get the same deal. Put that in something resembling English that I could understand. Meaning there is no maturity meaning there's no floor on the price and no time you get your money back no time you get your money back and bonds of the same company yields the same thing preferred stocks and good investment for corporate investors but not for individuals as

corporations get a tax break. They get a tax break. That's right Harvey eyes and a lot of newcomers to the financial markets are baffled by the relationship between the bond market and interest rates. As John mantra of Columbus Mississippi puts it generally you always say that if interest rates stay low it's good news for the bond market. And if interest rates rise it's bad news for the bond market. It seems to me that it should be the opposite reaction and higher interest rates to a higher return for a bond buyer. And that's a more attractive investment. I'm obviously missing the very basic point here please enlighten me. Great question a confusing subject. I think a simple answer. When you buy a bond and interest rates rise the price of the bond goes down. And when you buy a bond experience go down the price the bond rises. So the answer is he's absolutely correct. What you want to do is have high rates when you buy the bond. When you buy at lower rates thereafter. Yes correct. ALAN BOND How would you respond to Terry dent in the Bowling Green Kentucky whose letter is in

itself. A multimedia experience. I have a ringing desire he writes to dial out for some information on the new wireless phone system. I know you won't give me a wrong number and would appreciate your direct dialing me into one of your astute operators for assistance. Well there are a few things we can call up for Mr. Dent and he's right in that the wireless communications industry has been the recipient of a lot of attention. I think there are a number of ways to play the recent FCC decision especially in the wireless communication national paging network area. You have a company like mobile telecom traded over the counter intel. Also you have an old favorite in the manufacturing area like a Motorola that will position itself to compete very well. I also think that there are a number of companies that have done well in cellular like ilin broadcasting in cellular. So there's a lot of opportunities here. The question right now if you are tired of advice that comes on with a convincing ring but turns out to be just plain phone he would be happy to help you get rid of all your financial hangups.

So to get on the line to prosperity is push buttons by sending your questions to us here at Wall Street Week Owings Mills Maryland 2 1 1 1 7. That's Wall Street Week Owings Mills Maryland 2 1 1 1 7. This is not a recording. Now before we meet tonight's special guests let's take a look at the historic changes that are occurring in the industry he covers as a government that once gave its highest priority to arming the nation to fight the Cold War is now sternly sitting on defense. Over the past three decades as this chart shows defense spending peaked as a percentage of our gross national product at 9.6 percent in 1968 the height of the Vietnam War then saw its share of U.S. output cut in half to four point eight percent during Jimmy Carter's presidency before rising again under Ronald Reagan to a high of 6.5 percent in 1986. Since then the defense share of the economy has again been tumbling. It's down to 4.1 percent today. And the Clinton administration projects a further decline to 3.7 percent by

1997 America's latest rush to disarm has already reduced employment in the weapons industry from 3.7 million workers in 1987 to 2.7 million today. The parade of the largest project cancellations in recent years started in 1986 when the B-1 bomber manufacturing program passed its peak and Rockwell reduced its workforce by 60 800 workers. Two years later the Navy canceled the A6 G plane development program causing Grumman to cut thirty one hundred workers. Three major cancellations rocked the industry in 1991. First the Navy canceled its $4.4 billion 8:12 fighter plane project leading to 4000 pink slips at General Dynamics and 5000 at McDonnell Douglas then to mobile launch systems and the SRAM to short range nuclear attack missile programs were canceled costing twenty five hundred jobs at Boeing. Find a way to phase out of the B-2 stealth bomber program caused Northrop to cut fifteen hundred

jobs. Last year's biggest reduction came with the slimmy of NASA's space shuttle program leading to the loss of 800 jobs at Martin Marietta. While a few areas of the country have been immune to the effects of the shift away from defense the three states that have lost the most jobs since the mid 80s as a direct result of project cancellations are first and foremost California where 200 32000 defense workers have been let go. Followed by New York where 54000 jobs have been cut due to cancellations. And New Jersey where 31000 defense workers have lost their jobs. What is the future for this industry and the workers who have counted on it for decades to put dinner on the family table. For some thoughts on that let's go over now and meet tonight's special guest Phil Friedman. Phil welcome. Pleased to have you. Thank you. The place Phil Friedman became a defense analyst in 1984 and his career has burgeoned even as the industry has shrunk for the

past three years. His base has been Morgan Stanley where he follows the aerospace defense electronics and multi industry companies and the Wall Street Journal this year named him the best stock picker in his defense and aerospace category. Phil Russia is unsettled and there is talk now of using U.S. forces on three different continents. Is there any chance of a trend toward a smaller defense budget will at least be slowed now. I don't think that the TO percent decline in defense spending for hongbin research will be slow that I think the things you talk about will be the things that will prevent it from going down to a 10 percent or more decline that the more bearish people would have suggested. So you think the Course that's been announced will be adhered to and it will won't either pick up or get worse. I think within a couple of percentage points that's correct despite the decline of the industry that we've seen the stocks have done well and you. But on top of why is it even though the revenues would be going down. The hemorrhaging has been ending. Clearly operating margins have been increasing as procurement practices have changed. Cash flows have been increasing. Balance sheets are very solid. Companies are buying back stock

and making very positive acquisitions. The stocks got to below the post-Vietnam lows after the Wall came down. That makes for a good stock move. They've had a pretty good move. Is it too late to buy them. I don't think so I characterize this as being in the fifth or sixth inning of the stock price move which is particularly attractive now. Right now we have about five or six recommendations looking at that too right now I'd say the Grumman and Martin Marietta are the two favorites that we have among the mid to large cap stocks in the smaller cap names that we put Thiokol. We also are recommending Jehl dynamics McDonnell Douglas and Alliant tech systems. Could you give us maybe a sentence about that I'm sure Grumman shareholder orientation companies buying back stock and I think they're going to sell some core assets and it's cheap. Martin Marietta bought aerospace double the size of the company. It's cheap undervalued relative to different electronics stocks. Gentlemen Onix meant that Hynix management management management great monetization story is still ongoing.

McDonald Douglas generating a lot of cash this year close to a billion dollars to small cap situations like tech systems cheap and focusing on defense making ammunitions acquisitions. Thiokol. Cheap I think they're about to embark on an acquisition of a solid rocket motor company which I believe will be highly additive to earnings. You haven't mentioned the best known of the more peace oriented aerospace companies Boeing. Are you diminished prospects now in the near-term I am trimming the next 12 to 18 months. I think that there's another 10 to 15 percent downside to go. I think that we have more deferrals in cancellations and more production rate decreases to come. Is that a sign of the weak economy in general. Yeah Boeing is in part to play on the world's economy. Clearly now the relationship between this president and the defense industry is particularly ticklish. How would you assess it now. I think that Clinton is in fact pro defense contractor. He's clearly been more industrial base oriented. Witness the third Seawolf the gel the

namak is going be getting witness some changes that have taken place and procurement policies. And lastly I would point to his willingness to consolidate the industry defense contractor oriented as opposed to what. As opposed to I just think I think what we need for defense and I think I think he's clearly not going to slash the budget perhaps as much as other people thought he was going to. So. So their nerves have been calmed a little bit. I think they have I think the fear was that we would move into a 10 percent or more negative growth in on the fence and I think he's he is as you said calm those fears. Let's let's bring in my defence allies starting with Colorado. Let me be a devil's advocate for a second. I hear about restructuring and cost reduction and I understand that and cheapness of stark but it bothers me that the the customers of the aerospace industry in particular are broke. Uncle Sam the airlines foreign governments

foreign airlines. There's no growth in unit sales. How do you respond. OK. Clearly I'm in the commercial aircraft industry. I would concur with that. And that's why at present we're not pro commercial air space and defense I think that it is clearly a bottom line story. The top line is going down the margins are increasing because of changes that have taken place and they're generating cash and at some price something has value. And these stocks have clearly got that value and below some you know Phil it used to be in the stock market when a company was acquired that's a stock that did very well in your industry the acquiring company seems to do even better than the acquired company. Why is that. Take an example. Martin Marietta are they buy General Electric aerospace. Double the size of the company. It adds the dollar per share to earnings and you get a relative multiple pop because they have a more diverse program base. The stock's up 50 percent and it's still selling at a lower multiple than its peers.

At this point in time they'll have some of the international issues and crises that we witnessed in the last few months impacted your opinions on some of these companies. And would you forecast what international growth might that might pose for these companies. It hasn't materially impacted my philosophy again. I think that the path that we're on is pretty well set. But I would suggest that some areas of the Pacific Rim and the Middle East are still going to be sources of revenue for these companies in the Pacific Rim. Clearly with North Korea and China acting as they are that's going to be a mitigator for U.S. defense sales declines. We'll follow it up when Allen just asked you. With the Cold War over at least apparently at least for now. We clearly don't need huge nuclear bombs the way we used to but we still need smart weapons and intelligence. What do these companies have especially in that area. Like tech systems is a pure ammunitions manufacturer of some of the things they're clearly working or are these smart smart weapons area. Some other companies like Marietta

are also working on something there but I think in terms of a play on that it's clearly a lot of tech systems. We began this discussion of the subject by talking about all the workers who had lost their jobs. Would you advise anyone to seek a job in the defense industry no. At most levels I would really advise not. I still think that defense employment will be going down between 8 8 to 10 percent a year the next several years. Do you see changes in the shape of the industry. I clearly do. This administration is encouraging consolidation. For example they're suggesting we go from five military aircraft contractors to two. Five solid rocket manufacturers down to two. We're already accepted the fact that there'll be one submarine manufacturer not two. So I clearly think that it's consolidating that's a very positive part of my thesis. And are these less sensitive to the overall economy than certainly than the civilian aircraft industry. But then the market in general. Oh no question about it. If the economy is up 2 percent rather than up 3 percent the defense budget is going to be what it was going to be so I think will

be relatively unaffected. You already alluded to how cheap these stocks were after the Berlin Wall came down. How cheap were they. These stocks were selling at well under four times cash flow in many cases and very depressed cash flow multiples or they were selling in many cases at five times earnings or less. They're now at about seven to nine times earnings. They're now at about five times Tassell a little bit less. They're still very cheap. So you see a world without a Cold War but still a world world is dangerous enough to provide employment for some of these people. If the bottom line is going up I generally do. Thanks very much Phil Friedman. Thanks to all of our panelists. Hope you'll be back with us again next week. My guests will be the most influential woman in Wall Street. She's a lame guards Ereli the top right quantitative analyst who has a record of success and flair for drama have combined to bring her unprecedented attention and she'll be giving her latest analysis to us. Meanwhile this has been Wall Street Week. I'm Louis Rukeyser.

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