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Bright Near-Term Outlook for Aerospace-Defense Equipment Stocks

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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 (MRO) activities to defense players.

Here are the three major themes in the industry:

  • While rising competition has frequently prompted industry bigwigs to expand their product lines through small and medium size acquisitions, lately there have been some big mergers in the industry. These can be attributed to the growing importance of cost reduction initiatives and increased control over production procedures. For instance, United Technologies completed the acquisition of Rockwell Collins for $30 billion in November 2018 to emerge as one of the world’s largest aircraft-equipment manufacturers. Such consolidation of production by leading industry players should improve economies of scale for the aerospace-defense equipment industry, as a whole.
  • Being the largest digitally advanced nation, the United States is rapidly enhancing its electronic warfare, C4ISR (Command, Control, Communication, Computers, Intelligence, Surveillance and Reconnaissance) and cyber security measures, following rampant cyber-attacks that affected a number of countries last year. According to Transparency Market Research, the global C4ISR market is expected to witness CAGR of 3.8% from 2018 to 2026, with North America dominating the market. This should further drive prospects of the stocks in this space, especially those providing defense electronics.
  • The imposition of import tariffs on aluminum and steel by the Trump administration this May has proved to be detrimental as these are the raw materials required to manufacture vital aerospace and defense equipment. With declining operational aluminum smelters in the country, the United States largely depends on foreign countries for aluminum supply, and such a regressive tariff increases the possibility of a rise in costs and disruption of supply chains. According to a report by Aerospace Industries Association (AIA), this tariff threatened the job of 2.5 million people employed in the U.S. aerospace and defense space.

Zacks Industry Rank Reflects Encouraging Prospects

The Zacks Aerospace-Defense Equipment industry is housed within the broader Zacks Aerospace sector. It carries a Zacks Industry Rank #28, which places it in the top 11% 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 bright 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 in the past few months. Evidently, the industry’s earnings estimates for the current fiscal year have gone up by 1.1% since September 2018.

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 Outperforms S&P 500 and Sector 

The Aerospace-Defense Equipment industry has outperformed the Zacks S&P 500 composite as well as its own sector over the past year. The stocks in this industry have collectively gained 2.2%, while the Aerospace sector has lost 1.5%. The Zacks S&P 500 composite has declined 0.7% in the same 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 equipment, the industry is currently trading at 1.99X compared with the S&P 500’s 2.76X and the sector’s 1.33X.

Over the past five years, the industry has traded as high as 2.32X, as low as 1.25X, and at the median of 1.60X, as the charts show below.

EV-Sales Ratio (TTM)

Bottom Line

The latest budget proposals from Pentagon that reflects hawkish spending provisions for the U.S. Department of Defense (DoD), along accelerating aircraft production with rapidly rising global air traffic, should keep U.S. Aerospace-Defense Equipment stocks’ momentum alive.

The impact of the recent tariffs might mar the industry’s growth prospects to some extent in the near term. However, given its favorable industry rank and price performance history, investors may bet on a few stocks in this space that exhibit a strong earnings outlook.

We are presenting four aerospace-defense equipment stocks with a Zacks Rank #1 (Strong Buy) or #2 (Buy) that investors may want to add to their portfolio. You can see the complete list of today’s Zacks #1 Rank stocks here.

AeroVironment, Inc. (AVAV - Free Report) : For this Monrovia, CA-based company, the Zacks Consensus Estimate for fiscal 2019 EPS indicates year-over-year improvement of 42.6%. It came up with average positive surprise of 257.01% in the trailing four quarters. It sports a Zacks Rank #1.

Aerojet Rocketdyne Holdings, Inc. (AJRD - Free Report) : The current year consensus estimate for this Sacramento, CA-based company indicates year-over-year improvement of 42.6%. It came up with average positive surprise of 19.27% in the trailing four quarters. It also sports a Zacks Rank #1.

Teledyne Technologies Inc. (TDY - Free Report) : For this Thousand Oaks, CA-based company, the Zacks Consensus Estimate for current-year EPS indicates year-over-year improvement of 37%. It came up with average positive surprise of 12.92% in the trailing four quarters. It sports a Zacks Rank #1.

Raytheon Company (RTN - Free Report) : For this Waltham, MA-based company, the Zacks Consensus Estimate for current-year EPS indicates year-over-year improvement of 32.6%. It came up with average positive surprise of 6.71% in the trailing four quarters. It carries a Zacks Rank #2.

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