Air travel restrictions in the wake of the coronavirus outbreak have weighed heavily on growth of the aviation sector, thus casting a shadow on commercial jet makers’ future. The economies are gradually opening up but lack of significant improvement in global passenger volumes over the past couple of months has worsened the situation.
Moreover, import tariff imposition on aluminum remains a threat for manufacturing stocks in the aerospace-defense space. Nevertheless, those manufacturers, which have a balanced portfolio with ample military products for sale, might be in a safe corner for the time being. The frontrunners in the aerospace-defense industry are
Northrop Grumman ( NOC Quick Quote NOC - Free Report) , L3Harris Technologies ( LHX Quick Quote LHX - Free Report) and Leidos Holdings ( LDOS Quick Quote LDOS - Free Report) . About the Industry
Zacks Aerospace-Defense industry comprises companies that primarily design and manufacture heavy-built products like commercial as well as military jets and helicopters, tankers and other combat vehicles, missiles, combatant ships as well as auxiliary ships, submarines, bombs, guns, space transportation vehicles, military satellites and a few more.
The industry also includes cyber security players who offer information technology (IT) services and C4ISR (command, control, communications, computers, intelligence, surveillance and reconnaissance) solutions.
A portion of revenues comes from defense contractors, offering spare parts, aircraft modification, ship repair and overhaul services and supply chain management services.
3 Trends Shaping the Future of the Aerospace-Defense Industry : The rapid spread of coronavirus outside China around middle of March 2020 forced governments to implement stringent travel restrictions and as a result global air traffic was hit badly. Per a report published by the International Air Transport Association (IATA), in August, industry-wide revenue passenger-kilometers (RPKs) fell 75.3% year over year compared with 79.5% annual contraction in July. This reflects an increase in passenger volume from the record low point in April but the pace of improvement has been very slow. Such low passenger volumes hurt prominent jet makers like Airbus and Boeing ( Poor Air Traffic Indicates Dim Outlook BA Quick Quote BA - Free Report) since airlines have drastically lowered aircraft orders and, in some cases, cancelled them altogether. Consequently, premier jet makers have been experiencing a lackluster order trend, which in turn forced a handful of them to cut down or even halt production in some parts of their operation.
While the production halt is likely to weigh on future revenues, the plane makers are expected to incur expenses associated with the storage of the finished products that are ready for delivery. Moreover, reduced flights indicate lower revenues from the aftermarket services that the aerospace-defense stocks offer to airlines. Since the industry’s road to recovery is still a long one, with passenger volumes unlikely to reach pre-COVID level any time soon per analysts, aerospace-defense stocks near-term prospects seem to be bleak.
: While the coronavirus outbreak dealt a big blow to the commercial aerospace market, the defense side of the industry has been one of the U.S. economy’s most resilient sectors during the pandemic, as it was cushioned by steady government support. An expansionary budgetary amendment adopted by the U.S. government for defense further reflects this. Notably, President Donald Trump allocated generously to 2020 defense budget, ramping up Pentagon's spending power by 30% from 2019 to $738 billion. Per a recent article by the Wall Street Journal, the Pentagon has also accelerated contract payments to help the sector’s smaller suppliers. Military Business Offers a Breather
With the United States being the largest supplier of defense products, the nation’s aerospace and defense stocks continued to witness a smooth flow of orders from Pentagon and other U.S. allies even amid the pandemic. This indicates modest revenue generation for industry players like
Lockheed Martin ( LMT Quick Quote LMT - Free Report) , General Dynamics ( GD Quick Quote GD - Free Report) and Huntington Ingalls ( HII Quick Quote HII - Free Report) , which are more focused on the defense business for the coming days. : In January 2020, the Trump administration announced plans to expand its existing tariffs on imports of steel and aluminum. From Feb 8, steel and aluminum derivatives also came under the tariff mandate. This new import tariffs were in addition to 10% import tariffs imposed on aluminum and 25% import tariffs imposed on steel from most countries in 2018. Now the latest tariff expansion is expected to have dealt a heavy blow to the U.S. aerospace and defense industry, which relies heavily on imported aluminum. This is because such tariffs are bound to push up overall manufacturing cost of the industry, thereby increasing cost of the airplanes. Although trade negotiations are going on between the United States and Britain, there is no surety that the tariffs will be lifted any time soon. Import Tariff Imposition May Continue to Hurt Zacks Industry Rank Indicates Dismal Prospects
The Zacks Aerospace-Defense industry is housed within the broader
Zacks Aerospace sector. It currently carries a Zacks Industry Rank #208, which places it in the bottom 18% of more than 250 Zacks industries.
Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dull 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 over the past few months. Evidently, the industry’s earnings estimates for the current fiscal year have gone down 37.4% to $4.93 since March 2020.
Before we present a few aerospace-defense 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, Tops Sector
The Aerospace-Defense industry has underperformed the Zacks S&P 500 composite but outperformed its own sector over the past year. The stocks in this industry have collectively lost 30.4%, while the Aerospace sector has plunged 35.1%. The Zacks S&P 500 composite has however risen 14.1% in the said timeframe.
One-Year Price Performance Industry’s Current Valuation
On the basis of trailing 12-month EV/Sales ratio, which is used for valuing capital intensive stocks like aerospace-defense, the industry is currently trading at 1.59, compared with the S&P 500’s 3.94 and the sector’s 2.16.
Over the past five years, the industry has traded as high as 1.94X, as low as 1.06X, and at the median of 1.64X, as the charts show below.
EV-Sales Ratio TTM 3 Aerospace-Defense Stocks to Keep a Close Eye on Northrop Grumman: Based in Falls Church, VA, Northrop Grumman has developed into one of the top largest U.S. defense contractors in terms of revenues. Its product line is well positioned in high-priority categories, such as defense electronics, unmanned aircraft and missile defense. The Orbital ATK acquisition for $9.2 billion has earned the company an esteemed position in the global missile defense space, with enhanced footprint.
The Zacks Consensus Estimate for Northrop Grumman’s 2020 earnings indicates year-over-year increase of 5.9% and has moved up 0.2% in the past 60 days. The company delivered an average earnings surprise of 10.08% in the last four quarters. 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 Price and Consensus: NOC
L3Harris Technologies: Based in Melbourne, FL, L3Harris is a technology-oriented aerospace and defense player. The company is in the process of finalizing its position on the U.S navy's frigate program as a system integrator, with an initial 10-ship contract of over $300 million. Such notable contract wins indicate solid revenue generation prospects for this defense major over the long run.
The Zacks Consensus Estimate for L3Harris’ 2020 earnings indicates year-over-year increase of 13.4% and has moved up 0.1% in the past 60 days. The company delivered an average earnings surprise of 6.72% in the last four quarters. The company currently holds a Zacks Rank #2 (Buy).
Price and Consensus: LHX Leidos Holdings: Based in Reston, VA, Leidos Holdings is a global science and technology leader that serves the defense, intelligence, civil and health markets. In May 2020, the company completed the acquisition of L3Harris' security detection and automation businesses for $968 million. The addition of these businesses has expanded the scope and scale of Leidos Holdings’ global security detection and automation offerings
The Zacks Consensus Estimate for Leidos Holdings’ 2020 earnings indicates year-over-year increase of 5.2% and has moved up 0.6% in the past 60 days. The company delivered an average earnings surprise of 16.5% in the last four quarters. The company currently holds a Zacks Rank #2.
Price and Consensus: LDOS