As if the ongoing Israel-Hamas and Russia-Ukraine wars weren't causing enough geopolitical uncertainty across the world, Iran's first-ever direct attack on Israel over the weekend has further raised the stakes. As Israel mulls a potential retaliation, President Biden took to the Wall Street Journal this week to make the case for funding U.S. allies in Ukraine and Israel.

While these geopolitical flashpoints add to broader market volatility, investors might consider allocating some capital to defense stocks. Though defense spending accounted for almost 3.6% of GDP in 2023, and is projected to reach $1.07 trillion by 2034, brokerage firm Wells Fargo remains cautious about buying stocks in the industry on the Iran catalyst. 

Nevertheless, analysts at Wells Fargo called out two of their top defense picks in this environment, both of which provide tech services to the federal government. With these names fresh off Army contract wins, here's what investors need to know.

L3Harris

Formed in 2019 by the merger between Harris Corporation and L-3 Communications, L3Harris Technologies (LHX) is a major U.S. defense contractor. They develop and provide advanced technology solutions for aerospace and defense needs. Their areas of expertise span land, sea, air, space, and cyber domains. LHX currently commands a market cap of $38.2 billion.

LHX stock is down about 4% on a YTD basis. The stock offers a dividend yield of 2.29%, which is above the sector median of 1.64%. Moreover, the company has been raising dividends for the past 22 years - and with a payout ratio of 36.86%, it has headroom for continued growth.

The defense company is slated to report its Q1 results on April 25. For the recently concluded fourth quarter, L3Harris reported a beat on both revenue and earnings. Revenues arrived at $5.3 billion in Q4, up 17% from the previous year. Concurrently, EPS rose by 2.5% to come in at $3.35, surpassing the consensus estimate of $3.31. The company's EPS has topped expectations in each of the past five quarters.

The company generated net cash from operating activities of $789 million, compared to $782 million in the year-ago quarter, and closed the quarter with a cash balance of $560 million.

Supporting its robust fundamentals, the company now has products in more than 75% of all domestic missile programs. Further, L3Harris got roughly $23 billion in new orders, pushing its book-to-bill ratio to 1.18x. 

More recently, LHX bagged a $256 million order from the Army for night-vision binoculars. Other key orders include contracts for the Army's manpack and leader radios, Compass Call missionized business jets, and rocket motors for the Army's guided multiple-launch rocket system. Overall, LHX's order backlog currently stands at $33 billion.

On average, analysts expect L3Harris to report earnings growth of 4.4% in the next quarter and 3% in FY 2024.

Overall, analysts have a rating of “Moderate Buy" for LHX stock with a mean target price of $239.39. This indicates an upside potential of about 18.5% from current levels. Out of 19 analysts covering the stock, 12 have a “Strong Buy” rating, 2 have a “Moderate Buy” rating, and 5 have a “Hold” rating.

Leidos Holdings

Reston, Virginia-based Leidos Holdings (LDOS) was founded in 1969 as Science Applications International Corporation. It became Leidos Holdings in 2016 through a merger with Lockheed Martin Information Systems & Global Services. They provide scientific, engineering, system integration, technical services and solutions to various government and commercial clients. Key areas of focus include intelligence and surveillance, cybersecurity, complex logistics, health, and energy. Its market cap currently stands at $16.8 billion.

LDOS stock is up 14.3% on a YTD basis. Leidos offers a dividend yield of 1.19%, backed by five years of consecutive increases. Additionally, with a payout ratio of just 20.27%, these payouts are well covered by the defense company's earnings.

Slated to report its Q1 results on April 30, Leidos reported solid numbers for the latest quarter as its Q4 revenue and earnings surpassed Street expectations. Revenues for the period came in at about $4 billion, which denotes a yearly growth of 7.7%. EPS grew by 8.7% from the previous year to $1.99, coming in above the consensus estimate of $1.74. The company's EPS has beaten expectations in four of the past five quarters.

Leidos reported net bookings of $2.8 billion in the fourth quarter, and exited 2023 with an order backlog of $37 billion, up from $35.8 billion in 2022. Notably, the company recently won a follow-on prime order worth $267 million from the Army to provide technology-enabled services, including hardware sustainment, modernization, refresher training, and logistics support.

Net cash from operating activities came in at $304 million, more than doubling from the prior year's figure of $125 million, and Leidos closed the quarter with a cash balance of $777 million.

The Department of Defense's increased focus on increasing capabilities through investments in IT or digital modernization bodes well for Leidos, given its expertise in the area. The company's largest segment is National Security and Digital, which provides technology-enabled services including software, cybersecurity, logistics, and decision analytics - all of which are key to the digital transformation program in force across U.S. federal agencies. 

The positive momentum extends beyond its core markets. Their Commercial and International segment leverages engineering talent to expand globally. AUKUS' nuclear submarine project in Australia could fuel demand for Leidos' IT expertise in intelligence data and digital systems. Additionally, the Defense segment is poised for multi-year growth driven by hypersonic technology, where Leidos is actively engaged with domestic clients.

Looking ahead, analysts are expecting Leidos to report an earnings growth of 6.30% in FY 2024.

Overall, analysts have deemed the stock a “Strong Buy” with a mean target price of $135.33. That indicates expected upside of 9.3% from current levels. Out of 14 analysts covering the stock, 12 have a “Strong Buy” rating and 2 have a “Hold” rating.