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U.S. Aerospace & Defense to Soar on Budget, Air Traffic

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The Trump presidency has been a major boon for the aerospace and defenseindustry, as can be seen from the industry’s stock market performance. Since the November 2016 election, stocks in the Zacks Aerospace & Defense sector +61.8%, handily outperforming the S&P 500 index’s +26.8% gain in the same time period. While the easy gains in the space have likely been made already, one can reasonably expect the overall trend to remain favorable.

The factors helping the group’s positive momentum to remain in place include the latest budget proposals from the Pentagon. The recent cabinet reshuffle that has brought in personalities perceived to be more hawkish has further improved the outlook for this space. Increased defense spending by other nations, particularly emerging markets, and greater awareness of cyber security vulnerabilities worldwide should continue to support the group.

Many of the Aerospace majors in the nation are doing a decent job, propelled by the following strategies:

Recent Upside in Budget: On Feb 12, 2018, Pentagon unveiled the fiscal 2019 (FY 2019) budget proposal outlined by President Trump, intended to strengthen the country’s military capabilities. Notably, the budget proposal aims at spending $716 billion on national security.

Of the total, $686.1 billion is being kept as funding for the Pentagon, reflecting 5% real growth over the initial FY 2018 President’s budget and 10% real growth over the current Continuing Resolution (CR). The budget includes $617.1 billion as base budget, highlighting a 17.8% increase from the 2018 current CR level and $69 billion for Overseas Contingency Operations.

Notably, the fiscal 2019 budget raises the end strength for the Army, Navy and Air Force by 25,900 over the fiscal 2018 budget. The latest budget’s major war fighting investments include spending plans of $21.7 billion on aircraft, $18.3 billion on shipbuilding and $5.8 billion on ground systems. No doubt, once approved by the U.S. Senate, this budget will lead to greater revenue growth for aerospace and defense stocks.

U.S. Leads Global Defense Exports

As the United States is the largest supplier of defense equipment, it is undoubtedly a golden era for Aerospace & Defense stocks. U.S. defense majors are expanding their foreign markets rapidly, taking advantage of regional tensions prevailing in the Middle East.

According to the latest report from Aerospace Industries Association, the United States led the global exports in the aerospace and defense segment in 2017. The country accounted for 34% of the total industry export. Further, per the U.S. Department of Commerce, the defense segment generated an astounding $143 billion from exports alone.

Of the recent foreign military sales (FMS) contracts, notable is the $6.2 billion deal that Boeing (BA - Free Report) won late last December for procuring 36 new F-15QA aircraft for the Qatar Emiri Air Force. Meanwhile, Lockheed Martin secured a modification contract worth $945 million to exercise production option of fiscal 2018 Patriot Advanced Capability-3 (PAC-3) missiles for Qatar and Saudi Arabia. With more similar FMS contracts anticipated in coming days, surely the U.S. defense majors will flourish manifold.

Rising Air Traffic: Rising trade activity worldwide of late, particularly in the Asian market, has been fueling air passenger as well as freight traffic which in turn is boosting demand for commercial airplanes. Evidently, as per the latest report by the International Air Transport Association (IATA), global passenger traffic surged an annual 7.9% in 2017, driven by demand growth of 7.6% led by Asia-Pacific and Latin America regions.

Robust regional economic expansion and an increase in route options for travelers primarily drove demand growth for Asia-Pacific carriers. On the other hand, Middle East has lately emerged as a lucrative growth market for commercial jet makers.

In line with this, in its latest market outlook, aerospace behemoth Boeing announced that it expects the commercial fleet to be fueled by sustained 4.7% annual growth in commercial passenger traffic, during 2017-2036. Per its projections, the world will need new planes worth $6.1 trillion, during 2017-2036, which reflects a 3.6% rise in jetliner demand compared with its prior 20-year forecast.

However, Airbus EADSY raised its 20-year forecast for jetliner demand by 6%, suggesting that the world will need new planes worth $5.3 trillion during 2017-2036. Since Boeing and Airbus dominate the commercial aerospace manufacturing market, there is no doubt that such an outlook indicates increased growth opportunities for commercial jet makers.

Single-Aisle Jets More in Vogue: It is imperative to mention here that in the commercial jetliner space, single-aisle jets are dominating. The expected growth in the single-aisle airplane segment is largely owing to the global popularity of the low-cost carrier business model and the expansion of air service into emerging markets such as Asia, which is compelling airlines to accelerate the replacement of aged airplanes.

In line with this, Boeing expects single-aisle jets to comprise 72% of the total commercial jet projection, thereby indicating worldwide demand for 29,530 single-aisle jets, worth $3.2 trillion, during 2017-2036. This figure reflects a 5% increase over last year's projection. Hence, with top notch jet peers like Boeing and Airbus eyeing the single-aisle jet market to further expand their business, we may expect to see further upside in the commercial aerospace market.

Restructuring: To maintain margins in a tough business environment, companies are squeezing costs out of their operations and diversifying into new business areas. In line with this, it is imperative to mention that Boeing and Lockheed Martin were an integral part of the first “Space Race” and poised to be a major player in the recently reinvigorated domestic space program. The latest project includes plans to land humans on Mars by the 2030s.

Moreover, Boeing in collaboration with NASA’s Space Launch System (SLS) will deliver “Deep Space Gateway” and “Deep Space Transport.” Management expects to construct the gateway in four launches by the early 2020s. Interestingly, Trump’s fiscal 2019 budget proposal includes provisions worth $3.7 billion for SLS and Orion, which would keep the programs on track for a test launch by 2020. These in turn will benefit stocks like Boeing and Lockheed Martin engaged in SLS.

Increased Focus in Cyber Spending: The latest hacking of Equifax’s database that compromised sensitive information of 143 million U.S. consumers, is a bright instance that computer attacks have emerged as the most pressing security challenges affecting global economy. To be on the safe side, the United States — the largest digitally advanced country — is enhancing its electronic warfare, C4ISR (Command, Control, Communication, Computers, Intelligence, Surveillance and Reconnaissance) and cyber security. In this context, Trump’s proposed FY 2019 budget allocates $8 billion to facilitate the nation’s primary cyber missions. This investment will offer the necessary resources to sustain the 133 Cyber Mission Force (CMF) teams established at Cyber Command.

Mergers & Acquisitions: New macro challenges along with rising completion are prompting aerospace and defense industry players to revisit their business models as well as expand their core operations and product lines. One such example is the deal worth $9.6 billion that General Dynamics announced last month for purchasing CSRA, in a bid to venture and gradually expands the government sector business. With this buyout, the shipbuilder aims at becoming the premier provider of high-tech IT solutions to the Government Technology Services market.

In September 2017, the industry witnessed two mergers, wherein United Technologies agreed to take over Rockwell Collins for $30 billion to create one of the world’s largest aircraft-equipment manufacturers. In the same month, Northrop Grumman agreed to buy rocket-maker Orbital ATK, for $9.2 billion. On completion, the new Aerospace behemoths will be able to generate more revenues for the industry.

Stocks to Consider

Considering the aforementioned drivers of the aerospace and defense stocks, we remain positive on stocks like The Boeing Company (BA - Free Report) , Huntington Ingalls Industries, Inc. HII and Wesco Aircraft Holdings, Inc. WAIR. While Boeing and Huntington Ingalls sport a Zacks Rank #1 (Strong Buy), Wesco Aircraft carries a Zacks Rank #2 (Buy). You can seethe complete list of today’s Zacks #1 Rank stocks here.

We may also consider better-ranked stocks like Lockheed Martin Corp. LMT, General Dynamics, Corp. GD and Northrop Grumman Corp NOC, which carry a Zacks Rank #3 (Hold).

Bottom Line

Increasing geo-political tensions across the globe have spurred nations to ramp up their arsenal and with the United States being home to the world’s major weapons manufacturers, demand for its defense equipment is growing by leaps and bounds. On the other hand, booming trade activity across the globe followed by notable economic growth has been fueling the commercial jet space. Considering the favorable macroeconomic attributes as well as budgetary upgrades, it seems wise now to invest in U.S. aerospace and defense stocks. 

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