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Outlook for Aerospace-Defense Stocks Remains Encouraging

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The Zacks Aerospace-Defense industry comprises firms 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 that offer information technology (IT) services and C4ISR (command, control, communications, computers, intelligence, surveillance and reconnaissance) solutions.

A portion of revenues for this industry comes from defense contractors that offer spare parts, aircraft modification, ship repair and overhaul services and supply chain management services.  

Here are the three major industry themes:

  • A steady improvement in global air traffic has pushed up commercial airplane demand, thereby giving an impetus to the U.S. Aerospace and Defense industry. Boeing, the largest jet maker, expects that the world will need 42,730 new planes, worth $6.35 trillion, between 2018 and 2037, per its latest Commercial Market Outlook (CMO). Impressively, this estimate reflects a 4.1% improvement in the company’s earlier 20-year outlook. Such improved projection is based on strong air-traffic trends in the emerging markets of China and India, along with the established markets of Europe and North America. On the other hand, increasing jet demand is expected to drive the aviation services market. To this end, Boeing expects commercial aviation services market to grow 4.2% annually, thereby reaching a value of $8.8 trillion over the next 20 years. This once again should significantly drive the top line of this industry.
     
  • With the United States being the largest supplier of defense equipment, it is undoubtedly a golden era for the nation’s aerospace and defense stocks. U.S. defense majors are expanding their foreign markets rapidly, particularly taking advantage of regional tensions prevailing in the Middle East lately. According to the latest report from Aerospace Industries Association (AIA), in 2017 the U.S. defense industry generated $20 billion worth of exports, which grew a solid 75% over the past decade. With no indication of the global geopolitical unrest coming to an end and emerging nations like Japan and India raising their defense budgets, this winning streak is expected to continue in the near term.
     
  • The industry is facing impending retirements and a shortage of trained technical graduates. Per a recent report by AIA, approximately 60% of aerospace and defense employees are more than 45 years old versus 44% in the overall U.S. workforce. This growing number of aged employees, coupled with high attrition rates and increased labor mobility, poses serious risks to the industry. In fact, employment in this industry fell 1.6% over the last five years in 2017. If the trend persists, it may impact business growth over the near term.

Zacks Industry Rank Reflects Bright Prospects

The Zacks Aerospace-Defense industry is housed within the broader Zacks Aerospace sector. It carries a Zacks Industry Rank #75, which places it in the top 30% 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 3.5% 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 Underperforms S&P 500 and 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 lost 7.1%, while the Aerospace sector has lost 7%. The Zacks S&P 500 composite has declined 4.8% 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, the industry is currently trading at 1.49 compared with the S&P 500’s 2.73 and the sector’s 1.34.

Over the past five years, the industry has traded as high as 1.83X, as low as 1.30X, and at the median of 1.67X, as the charts show below.

EV-Sales Ratio (TTM)

 

Bottom Line

Macroeconomic statistics like the nation’s declining unemployment rate as well as improving GDP growth are boosting growth prospects. Naturally, these have set the stage for more upside in the aerospace-defense industry, since a strong economy can better support defense funding. On the commercial front, demand for new jets is expected to increase as a big fleet of old airplanes are set to retire in the next couple of years.

However skilled labor shortage in the U.S. aerospace-defense industry remains a cause of concern. Nevertheless, to address this issue, in July 2018, a handful of major U.S. aerospace and defense contractors like Boeing, General Dynamics and Huntington Ingalls (HII - Free Report) pledged to enhance employment opportunities in the industry.

Given the industry’s favorable rank and earnings expectations, investors may bet on a few stocks in this space that exhibit a strong earnings outlook.

We are presenting four aerospace-defense 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.

Lockheed Martin Corp. (LMT - Free Report) : For this Bethesda, MD-based company, the Zacks Consensus Estimate for 2019 EPS indicates year-over-year improvement of 11.3%. It came up with average positive surprise of 13.92% in the trailing four quarters. It sports a Zacks Rank #1.

Northrop Grumman Corp. (NOC - Free Report) : For this Falls Church, VA-based company, the Zacks Consensus Estimate for 2019 EPS has risen 13% in past 90 days. It came up with average positive surprise of 17.87% in the trailing four quarters. It carries a Zacks Rank #2.

The Boeing Co. (BA - Free Report) : For this Chicago, IL-based company, the Zacks Consensus Estimate for 2019 EPS indicates year-over-year improvement of 21.1%. It came up with average positive surprise of 28.01% in the trailing four quarters. It holds a Zacks Rank #2.

Engility Holdings : For this Chantilly, VA-based company, the Zacks Consensus Estimate for current-year EPS indicates year-over-year improvement of 5.1%. It came up with average positive surprise of 19.9% in the trailing four quarters. It carries a Zacks Rank #2.

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