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4 Aerospace-Defense Stocks to Buy as Air Traffic Outlook Improves

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Recent improvement observed in global air travel has prompted IATA to enhance its air traffic outlook for 2021, which, in turn, is expected to benefit commercial jet makers. Lower loss for airlines might translate into cash for investment in new jet orders. Expansionary U.S. defense budget should benefit companies, which are more focused on the defense business, in the coming days. However, the U.S. defense electronics supply chain disruption due to the COVID-19 pandemic remains a threat for stocks in the aerospace-defense space. Nevertheless, improving travel statistics should keep investors interested in this industry. The frontrunners in the aerospace-defense industry are Lockheed Martin (LMT - Free Report) , Northrop Grumman (NOC - Free Report) , Textron (TXT - Free Report) and Leidos Holdings (LDOS - Free Report) .     


About the Industry

The 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

Improved Air Traffic Outlook Boosts Prospects: Global air traffic, which has been suffering since last March following the widespread outbreak of coronavirus worldwide, has been showing signs of improvement lately.  As estimated by the International Air Transport Association (IATA) in April 2021, air passenger traffic measured by revenue passenger kilometers will recover to 43% of 2019 levels over 2021, which reflects a 26% improvement when compared to 2020’s figure. This should bode well for commercial aerospace giants like Airbus and Boeing (BA - Free Report) , which have long bore the brunt of poor air travel in the forms of delayed jet deliveries and even, in some cases, cancellation of their orders altogether by airlines. Buoyed by rapid vaccination drive prevalent across the globe, IATA now expects the airline industry to lose $47.7 billion in 2021, which indicates an improvement from the prior loss projection of $126.4 billion. This might allow airlines to invest in new jets, thereby boosting near-term growth prospects of commercial jet manufacturers and associated companies.
 
Military Business Continues to Be a Growth Catalyst: While the commercial aerospace market has started to recover recently, the defense side of the industry has been consistently offering support, cushioned by steady government support. An expansionary budgetary amendment adopted by the former U.S. government for defense has acted as a major catalyst for this. Notably, under Donald Trump, defense spending increased nearly 15%, as stated by a Bloomberg article. A similar trend is being followed by the current U.S. administration as well. Evidently, President Biden’s fiscal 2022 defense budget request includes an investment option worth $715 billion for the Department of Defense (DoD), which compared to the prior year’s enacted amount of $703.7 billion indicates a 1.6% increase. Such improved budgetary provisions set the stage for industry players like General Dynamics (GD - Free Report) , L3Harris Technologies (LHX - Free Report) and Huntington Ingalls, which are more focused on the defense business.
 
Supply Chain Issues May Hurt: Supply chain disruption has been observed in the Aerospace and Defense industry, of late, courtesy of the COVID-19 pandemic induced lower aircraft demand and restrictions on the movement of people and goods. This primarily affected smaller suppliers, especially those with heavy exposure to commercial aerospace and the aftermarket business. In particular, the United States is facing shortages and security vulnerabilities with printed circuit boards and integrated circuit substrates crucial to its weapons systems, as published by a report in Forbes. Although the situation is improving, the entire impact of coronavirus on the global economy and threat of U.S. defense electronics supply chain disruption are unlikely to subside soon. This in turn might keep the growth trajectory of the U.S. aerospace and defense industry constricted in the near term.

Zacks Industry Rank Indicates Bright Prospects

The Zacks Aerospace-Defense industry is housed within the broader Zacks Aerospace sector. It currently carries a Zacks Industry Rank #78, which places it in the top 31% 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 attractive 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 top 50% of the Zacks-ranked industries is due to a positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts have gained confidence in this group’s earnings growth potential over the past few months. Evidently, the industry’s earnings estimate for the current fiscal year has gone up 1% to $7.96 since March 2021.

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 & Sector

The Aerospace-Defense 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 gained 22.8%, while the Aerospace sector has surged 30.5%. The Zacks S&P 500 composite has risen 38.3% 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 2.12, compared with the S&P 500’s 5 and the sector’s 2.73.

Over the past five years, the industry has traded as high as 2.19X, as low as 1.52X, and at the median of 1.87X, as the charts show below.

EV-Sales Ratio TTM



4 Aerospace-Defense Stocks to Add to Your Portfolio

Lockheed Martin: Based in Bethesda, MD, Lockheed is the largest defense contractor in the world. Its product line includes renowned fighter jets like F-35, F-16, C-130J along with combat proven missiles like Terminal High Altitude Area Defense System (THAAD) and PAC-3 Missiles. It is also the manufacturer of the Aegis Combat System, which is referred to as the world’s most advanced combat system. The company is set to complete its Aerojet Rocketdyne’s acquisition this year, which will enable it to expand its footprint in the rocket engine market, apart from boosting its hypersonic technology related product line.

The Zacks Consensus Estimate for Lockheed’s 2021 earnings has moved up 0.4% in the past 60 days and indicates year-over-year increase of 9.1%. The company delivered an average earnings surprise of 3.53% in the last four quarters.  The company currently holds a Zacks Rank #2 (Buy).



 

Northrop Grumman: Based in Falls Church, VA, Northrop Grumman is 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 company’s divestment of its federal IT and mission support services business to Peraton for $3.4 billion in cash will enable it to boost its share repurchase and debt retirement programs. This must have played part in Northrop’s dividend hike, announced in May 2021, thereby reflecting the stock’s solid financial position.

The Zacks Consensus Estimate for Northrop Grumman’s 2021 earnings inched up 1% in the past 60 days and indicates year-over-year increase of 3.6%. The company delivered an average earnings surprise of 13.20% in the last four quarters.  The company currently holds a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.



Textron: Based in Providence, RI, Leidos Holdings is a renowned manufacturer of military helicopters and other utility vehicles, apart from light- and mid-size business jets and many more industrial products. In March 2021, Textron received Federal Aviation Administration (FAA) Supplemental Type Certificate (STC) approval for the new Beechcraft King Air Ground Cooling aftermarket upgrade for Beechcraft King Air 200 and 300 series turboprops. Such approvals should boost Textron’s position in the combat aircraft market.

The Zacks Consensus Estimate for Textron’s 2021 earnings grew 4.6% in the past 60 days and indicates year-over-year increase of 52.7%. The company delivered an average earnings surprise of 75.88% in the last four quarters. The company currently holds a Zacks Rank #2.



 

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 April 2021, the company completed delivery of a cutting-edge autonomous vessel to the U.S. Navy, known as Seahawk. With improved defense budget, an inflow of contract for this product is expected in the days ahead, which in turn will boost Leidos’ organic growth trajectory. In May, Leidos completed the buyout of Gibbs & Cox, the largest independent ship design firm focused on naval architecture and marine engineering. This should strengthen Leidos’ position in the naval defense market.

The Zacks Consensus Estimate for Leidos Holdings’ 2021 earnings has risen 0.9% in the past 60 days and indicates year-over-year increase of 12.7%. The company delivered an average earnings surprise of 20.11% in the last four quarters. The company currently holds a Zacks Rank #2.

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