A drastic reduction in air travel across the globe hit the stocks in the Aerospace-Defense Equipment industry hard, especially those operating in the commercial space. This happened as near-zero level commercial aircraft production affected equipment manufacturing companies as demand for new and replacement equipment declined from the year-ago level.
Moreover, with the entire aviation industry pinned down by huge losses, uncertainty regarding the pandemic spooked fresh investments in the industry. Consequently, two prospective mergers got cancelled. Nevertheless, one cannot deny the fact that the inherent security issues prevalent worldwide are expected to persistently boost this industry. Some important players in this industry include Raytheon Technologies (RTX - Free Report) , Transdigm Group (TDG - Free Report) , Bae Systems Plc (BAESY - Free Report) and Heico Corp. (HEI - Free Report) .
About the Industry
The Zacks Aerospace-Defense Equipment industry comprises firms that manufacture a wide variety of vital components for the aerospace-defense space, ranging from aerostructures, space shuttles, propulsion systems, aircraft engines, defense electronics, missile and radar systems to flight test equipment, structural adhesives, instrumentation and control systems, communication products and many more. A few of these companies also offer integrated simulation and training services to the U.S. defense force.
While the majority of revenues is generated from production of the aforementioned accompaniments, the industry players also generate revenues by providing notable aftermarket support and services like maintenance, repair and overhaul activities to aerospace and defense players.
3 Trends Shaping the Future of the Aerospace-Defense Equipment Industry
Coronavirus-Led Crisis Hampering M&As: While rising competition has historically prompted industry majors to expand their product lines through small and medium-sized mergers and acquisitions (M&As), lately, some big mergers have been witnessed in the industry. However, amidthe economic crisis that arose from thenovel coronavirus outbreak, capital available for merger deals in the industry leading to their ultimate termination. Consequently, in the month of April, Boeing (BA - Free Report) terminated its joint venture with Embraer (ERJ - Free Report) , which would have given the American jet maker an 80% stake in Embraer’s commercial business. In the same month, Hexcel Corporation (HXL - Free Report) and Woodward announced termination of their previously-announced $6.4-billion merger deal. Such cancellations are expected to hurt economies of scale for the aerospace-defense equipment industry as a whole, which in otherwise situation would have been derived from the consolidated entity.
Poor Aviation Hurts Prospects: The global airline industry plunged into an unprecedented crisis this March, as bookings plummeted drastically in response to coronavirus-induced travel restrictions. This in turn hit the entire aircraft production ecosystem, as evident from a notable reduction in and cancellation of commercial aircraft order as well as delayed deliveries of the same. Consequently, original equipment manufacturers (OEMs) and their suppliers witnessed a decline in revenues and cash flow. The pandemic also hit the commercial aftermarket industry. It is imperative to mention in this context that although the economy has started to open up, demand in the aerospace-defense equipment industry is yet to pick up significantly or reach the pre-pandemic levels. This makes us skeptical about the growth prospects of this industry.
Socio-Political Uncertainty to Aid: Widespread geo-political as well as socio-economic tensions have been a growth driver for the aerospace and defense equipment industry for decades. In recent times, escalating international terrorist attacks along with civil wars like the onesin the Middle East have been adding more impetus to this space. Though the pandemic has dealt a significant blow to its growth trajectory, the inherent uncertainty and sustained complexity of the international security environment worldwide are expected to be beneficial for this industry.
Zacks Industry Rank Reflects Gloomy Outlook
The Zacks Aerospace-Defense Equipment industry is housed within the broader Zacks Aerospace sector. It currently carries a Zacks Industry Rank #211, which places it in the bottom 16% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates weak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
The industry’s position in the bottom 50% of the Zacks-ranked industries is due to a negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts have lost confidence in this group’s earnings growth potential in recent times. Evidently, the industry’s earnings estimates for the current fiscal year have gone down by 5% since Jun 30.
Before we present a few aerospace-defense equipment stocks that you may want to add to your portfolio, let’s take a look at the industry’s recent stock market performance and valuation picture.
Industry Lags S&P 500 and Sector
The Aerospace-Defense Equipment industry has underperformed the Zacks S&P 500 composite as well as its own sector over the past year. The stocks in this industry have collectively plunged 39.8% compared with the Aerospace sector’s decline of 38.1%. The Zacks S&P 500 composite has moved up 12.2% in the same timeframe.
One-Year Price Performance
Industry’s Current Valuation
On the basis of trailing 12-month EV/Sales, which is used for valuing capital intensive stocks like aerospace-defense equipment, the industry is currently trading at 2X compared with the S&P 500’s 3.76X and the sector’s 2.15X.
Over the past five years, the industry has traded as high as 2.17X, as low as 1.11X, and at the median of 1.94X, as the charts show below.
EV-Sales Ratio (TTM)
4 Aerospace-Defense Equipment Stocks to Keep a Close Eye on
Raytheon Technologies: Based in Waltham, MA, Raytheon Technologies is a pioneer in the U.S. missile defense space. Its combat proven portfolio of varied missile systems like Patriot, SM-6 and many more remain major growth drivers for the company. Following the mega-merger between Raytheon Company and United Technologies this April, which gave birth to Raytheon Technologies, the combined entity is expected to gain immense economies of scale leveraging the expertise of the two renowned corporations.
The Zacks Consensus Estimate for 2020 earnings has moved up 1.3% in the past 60 days. The Zacks Consensus Estimate for 2021 earnings has moved up 4% in the past 60 days. The company currently holds a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Transdigm Group: Based in Cleveland, OH, Transdigm Group’s diversified portfolio highly engineered proprietary aerospace components enjoy solid demand in the aircraft market. The company’s Esterline acquisition last year is projected to expand Trandigm’s market share significantly in the aerospace-defense equipment space, with significant aftermarket exposure.
The Zacks Consensus Estimate for fiscal 2020 earnings has moved up 6.6% in the past 60 days. The Zacks Consensus Estimate for fiscal 2021 earnings has inched up 0.8% in the past 60 days. The company currently holds a Zacks Rank #3.
BAE Systems: U.K.-based BAE Systems is a well known defense contractor that manufactures products ranging from warships, combat vehicles and aircraft to providing cyber security solutions. The company recently launched its Riptide unmanned undersea vehicle (UUV)-12 system, therebyextending the Riptide family of UUVs and capturing more market share.
The Zacks Consensus Estimate for 2020 earnings has moved up 4.8% in the past 60 days. The Zacks Consensus Estimate for 2021 earnings has moved up 3% in the past 60 days The company currently has a Zacks Rank #3.
Heico Corp.: Based in Hollywood, FL, Heico is one of the world’s leading manufacturers of Federal Aviation Administration-approved jet engine and aircraft component replacement parts. Impressively, while many companies are struggling, solid demand for Heico’s components used in medical equipment, such as ventilators, x-ray systems, sterilization equipment as well as personal protective equipment has helped it tide over the crisis.
The Zacks Consensus Estimate for fiscal 2020 earnings has moved up 15.2% in the past60 days. The Zacks Consensus Estimate for fiscal 2021 earnings has moved up 6.8% in the past 60 days. The company currently carries a Zacks Rank #3.