The last two months have been good for U.S. aerospace and defense companies — and the next two years could mark a bull market for stocks of those best-positioned for this new environment.

The turning point came in late October, when Congress and the Obama Administration agreed to a two-year budget deal that authorizes Pentagon spending over the next two years by about $37 billion more than the spending caps established by the so-called sequester budget agreement that began in 2012. That $37 billion was actually less than President Obama requested, but it’s still a major shot in the arm for the defense industry.

#-ad_banner-#To understand why, let’s review the trend in U.S. defense spending this century. After an uninterrupted annual rise since 9/11 — due in large part to the wars in Iraq and Afghanistan but also to substantial spending on new weapons programs for every branch and the burgeoning Homeland Security sector — defense spending fell about 15% total from fiscal 2011 (ended September 2011) through fiscal 2015. 

Part of the decrease was due to the U.S. winding down combat operations in Iraq, which corresponded to a contraction in the size of our armed forces. But the reduction also occurred because of sequestration: the automatic, across-the-board spending cuts triggered by the failure of Congress to strike a bipartisan budget deal in 2011. Sequestration impacted every area of the federal government, but it was particularly painful for defense contractors who had grown accustomed to higher and higher Pentagon budgets over the previous decade.

The end of sequestration thus opens up the possibility of rising revenue for military suppliers who are best positioned for the next phase of Pentagon and Homeland Security spending. Regardless of who wins next year’s presidential election, analysts expect that the next several years will see an increase in spending on next-generation weapons systems for asymmetrical warfare (i.e., against insurgents and terrorists rather than national armed forces) and new technologies that incorporate modern energy, telecom and information technology innovations.

Here’s an exciting stock worth buying today as a play on increased defense spending:

Arotech (Nasdaq: ARTX) doesn’t make weapons; it specializes in simulators/trainers and a mundane yet oh-so-important product: batteries. But not just any batteries; Arotech specializes in innovative high-performance lithium batteries, zinc-air batteries, smart chargers, water-activated lifejacket lights (WABs) for aviation and marine use and a variety of power systems and equipment. Its customers include modern military and homeland security forces — not only in the United States but in the Middle East, Europe and Asia.

Arotech also is the supplier of the U.S. Army’s SWIPES program, which stands for Soldier Worn Integrated Power Equipment Systems. These next-generation portable power systems are integrated into soldiers’ tactical vests and continuously charge the batteries in a soldier’s radio, GPS unit, shot-detection units and other electronic devices — while weighing less than two pounds. The company sees enormous growth potential for the system beyond the Army into the other branches, foreign militaries, and the first-responder market. 

Other power systems products include GREENS systems — lightweight, portable solar panels for field operations in “austere” environments such as deserts; huge batteries that can power missile launchers and other high-energy weapons; sophisticated power systems for unmanned vehicles such as drones and submarines; and high-end power systems for light armored vehicles that provide more power at lower weight than older technologies. All of these systems are being used now by various branches of the U.S. military, Israeli military and other customers, but there’s ample room for expansion in these markets and the corporate market (e.g., energy and construction companies).

Arotech also is the market leader in weapons simulators used in air combat training, and its technology now is also used in real-world tactical applications on every U.S. fighter plane to help pilots understand each of their weapon’s capabilities in high-speed situations. Arotech’s products also are used by municipal rail and bus drivers, military convey crews and pilots in vehicle safety training.

The company has grown through acquisitions such as the 2014 purchase of UEC Electronics, which specializes in vehicle power and clean energy power generation. But it has a healthy balance sheet, with debt only about one-quarter of equity.

This is a low-priced stock, which increases day-to-day volatility — so exercise caution. But it has solid technologies, a strong record and established relationships with major customers around the world and thus is a good bet on the rising defense budgets.

Risks To Consider: The biggest risk is a falling market share due to contract cancellations or procurement losses. As a low-priced stock, Arotech can be volatile, as small price movements account for relatively high percentage changes.
    
Action To Take: Buy Arotech below $1.90.

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