For 2017: Defensive Spirits or Spirited Defense Industry?

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Two drastically different industries, which will most likely make it in 2017, are Spirits and Defense.

One of the beauties to be in a sin industry, like spirits, is that price increases are welcome.  Sin industries such as tobacco, gaming, spirits, and firearms, are known to be recession-proof because their business models are based on human weaknesses.   Case in point, the demand for spirits is less sensitive to price increases but more so to demographic changes and regulatory environment. Both are long term in nature.

While the rising cost for barley due to supply shortages from France (-21%) and Germany (-9%) in 2016 will be eventually be passed onto brewers and end users, a 14-year high Dollar will be more than enough to help offset the rising import cost.  As most rising raw material costs for spirits, barley, malt, rice, and rye are fixed by long-term contracts, the resulting spirit price increases can be easily delayed and offset by the cyclical increases in demand.  In 2012, the Brewers Association reported that were 2,715 breweries compared to just 50 in 1980.  Brazil is expected to lead growth of whiskey in next few years.  Increased disposable income worldwide will lead to higher consumption and more so for premium brands.

Similarly, spirits’ ugly cousin, cigarette maker Altria, has enjoyed consistently high annual revenue growth despite a systematic reduction in annual shipments. This reduction is due to tougher regulations on cigarette consumption worldwide.  Since 1970, Altria stock (NYSE: MO) has returned 8856% to their shareholders compared to the S&P 500’s 2419%.

If there is any downside for consumers, as NAFTA and immigration laws could be altered, your favorite Tequila from Mexico could be affected.  The uncertainty and market volatility led Jose Cuervo to delay its $ 1 billion IPO.  Regulations could still hurt the industry. India only allows approved shops to sell spirits and whiskey is most consumed spirit in India.

For investors, spirits are defensive in nature.  Spirit stocks have rallied pre-New Year.  Even with promising December sales numbers, like most other stocks, a correction or pullback could be imminent.

If you think that this industry’s party is over, perhaps you should make a more spirited move… into defense.

The defense industry has been the talk of the town since Trump one the election. Terrorist attacks and sustained conflicts are, sadly, a beacon of hope for defense investors.

On the upside,  for the U.S., Trump has called for increasing the Army ranks by 17%, or about 90,000 additional soldiers,  building a Navy with 350 vessels (from 272 currently), and adding an additional 100 fighter jets.   The renewed emphasis on modernizing nuclear and missile defenses alone could be an increase of upwards of $100 billion annually.

For a bigger upside, the global aerospace and defense industry can be a direct beneficiary of a volatile and uncertain geopolitical global backdrop, characterized by terrorist threats, civil wars and border disputes. The U.S., a major exporter to the world’s major weapons manufacturers, is potentially the largest beneficiary of this environment.

On the downside, Trump’s trade policies could suppress overseas aircraft sales and affect international supply chains for aircraft manufacturers.  The supply chain shakeups may put Original Equipment Manufacturers (OEMs) in an awkward position — trying to reduce costs wherever possible while ramping up production.

Congress may consider closing the U.S. Export-Import Bank (Ex-Im), some viewed as “corporate welfare,” which financed 10% of Boeing’s aircraft sales in 2015.  Though, closing Ex-Im would be disadvantageous for U.S.-based companies. With Trump’s anti-welfare but pro U.S. business rhetoric, this issue is still up for debate.

For stockholders, as Dept. of Defense budget cuts have beaten defense stocks down for years, the stock market may have already priced in the best case scenario for budget increases after the election.  If Trump’s spending promises are not fulfilled or are not as substantial as the market wants, gains made in December could be erased.

For bondholders, higher interest rates could deter aircraft replacement spending programs.  If there is an economic downturn, enthusiasm for decreasing national debt may outweigh defense spending.

In the first trading session of 2017, the Dollar was trading at a 14-year high.  This is not a good news for any US exporters, aerospace-defense or not.

After all, Trump did not like the price tag of Air Force One or Lockheed Martin’s F-35 fighter jets.  He could always adjust spending budgets to favor a cheaper competitor.

It will be interesting to see what happens this year.

Defense or Spirits, it’s your call.

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