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Aerospace-Defense Equipment Outlook: Growth Prospects Plenty

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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 major portion 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, a strategic merger between L3 Technologies (LLL - Free Report) and Harris Corp. (HRS - Free Report) is around the corner. The combined company will become a global defense technology leader, with annual revenues worth $16 billion. 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.
     
  • In March 2019, the U.S. Department of Commerce initiated an investigation to determine whether the present quantity or circumstances of titanium sponge imports threaten to impair U.S. national security. An affirmative determination might result in imposition of tariffs or quotas on import of titanium sponge. Titanium sponge, made from titanium ore, is the primary form of titanium used in manufacturing varied defense products like aircraft structures and engines, munition systems, ground combat vehicles and ships. Unfortunately, there is only one domestic supplier of titanium sponge in the United States. On top of that, the manufacturing facility is more than 70 years old and needs $150 million for modernization (per a Forbes report). So, manufacturers have to rely on import of titanium sponge for smooth production. If the investigation results lead to imposition of import tariffs, it might hurt critical defense production.

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 #53, which places it in the top 21% 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% 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 Sector

The Aerospace-Defense Equipment industry has outperformed its own sector over the past year but lagged the Zacks S&P 500 composite. The stocks in this industry have collectively gained 10.4% while the Aerospace sector rose 4.3%. The Zacks S&P 500 composite has gained 10.8% in the same timeframe.

 

One-Year Price Performance

 

 

Industry’s Current Valuation

On the basis of trailing 12-month EV/Sales, which is used for valuing capital intensive stocks like aerospace-defense equipment, the industry is currently trading at 2.17X compared with the S&P 500’s 3.08X and the sector’s 1.45X.

Over the past five years, the industry has traded as high as 2.32X, as low as 1.95X, and at the median of 1.66X, as the charts show below.

EV-Sales Ratio (TTM)

 

Bottom Line

The fiscal 2020 budget proposal indicates solid 5% growth from last fiscal’s approved budget spending. Such hawkish spending provisions for the U.S. Department of Defense (DoD), along with accelerating commercial aircraft production on account of rapidly rising global air traffic, should keep U.S. Aerospace-Defense Equipment stocks’ momentum alive.

The tariffs on titanium sponge imports, if imposed, may mar the industry’s growth prospects to some extent in the near term. However, there’s still some uncertainty around it. Moreover, considering the industry’s favorable rank and price performance, 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.

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 5.6%. It came up with average positive surprise of 6.79% in the trailing four quarters. It sports a Zacks Rank #1.

Transdigm Group Incorporated (TDG - Free Report) : The current-year consensus estimate for this Cleveland, OH-based company’s sales indicates year-over-year improvement of 40%. It came up with average positive surprise of 5.3% in the trailing four quarters. It also sports a Zacks Rank #1.

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 62%. It came up with average positive surprise of 294.51% in the trailing four quarters. It carries a Zacks Rank #2.

Triumph Group, Inc. (TGI - Free Report) : For this Berwyn, PA-based company, the Zacks Consensus Estimate for current-year EPS indicates year-over-year improvement of 0.11%. It came up with average positive surprise of 1.64% in the trailing four quarters. It carries a Zacks Rank #2.

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