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Air Traffic Growth Boosts Aerospace-Defense Industry Prospects

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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 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. Per the latest forecast made by the International Air Transport Association (IATA), air passenger numbers are likely to double to 8.2 billion in 2037. Boeing, the largest jet maker, expects that the world will need 42,730 new planes, worth $6.35 trillion, over the next 20 years, to meet this demand. The new outlook reflects a 4.1% improvement from the company’s previous20-year outlook. The improved projection is based on strong air-traffic trends in the emerging markets of China and India, along with established markets of Europe and North America. 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 by 2037. This should significantly drive the top line of the industry.
  •  With the United States being the largest supplier of defense products, 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), the U.S. Aerospace and Defense industry generated $143 billion in exports and a positive trade balance of $86 billion in 2017, thereby effectively reducing the U.S. trade deficit by 10%. With no indication of the global geopolitical unrest coming to an end and emerging nations like Japan and India raising their defense budgets significantly, the 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% in the last five years up to 2017. If the trend persists, it may impact business growth over the near term.


Zacks Industry Rank Reflects Encouraging Prospects

The Zacks Aerospace-Defense industry is housed within the broader Zacks Aerospace sector. It currently carries a Zacks Industry Rank #86, which places it in the top 33% 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.

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 3.2%, while the Aerospace sector has slipped 0.8%. The Zacks S&P 500 composite has gained 4.3% 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 1.56 compared with the S&P 500’s 2.92 and the sector’s 1.44.

Over the past five years, the industry has traded as high as 1.77X, as low as 1.32X, and at the median of 1.61X, as the charts show below.

EV-Sales Ratio (TTM)


Bottom Line

It’s true that shortage of skilled labor in a vast industry like U.S. Aerospace and Defense remains a cause of concern. Nevertheless, a handful of major U.S. aerospace and defense contractors like Boeing (BA - Free Report) , General Dynamics (GD - Free Report) and Huntington Ingalls (HII - Free Report) have pledged to enhance the industry’s employment opportunities.

Meanwhile, the stupendous budget proposals from Pentagon, under Trump’s administration, reflect hawkish spending provisions for the U.S. Department of Defense (DoD). This along with enhancing demand for new jets courtesy of air traffic growth as well as ageing aircraft is expected to drive growth in the near term.

Given the industry’s favorable rank, 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 #2 (Buy) that investors may want to add to their portfolio. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) 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 16.7%. It came up with average positive earnings surprise of 17.35% in the trailing four quarters.

Northrop Grumman Corp. (NOC - Free Report) : For this Falls Church, VA-based company, the Zacks Consensus Estimate for 2019 EPS has risen 1.8% in the past 90 days. It came up with average positive earnings surprise of 18.50% in the trailing four quarters.

Leidos Holdings, Inc. (LDOS - Free Report) : For this Reston, VA-based company, the Zacks Consensus Estimate for 2019 EPS indicates year-over-year improvement of 4.6%. It came up with average positive earnings surprise of 6.81% in the trailing four quarters.

Wesco Aircraft Holdings, Inc. WAIR: For this California-based company, the Zacks Consensus Estimate for current-year EPS indicates year-over-year improvement of 12%. It came up with average positive earnings surprise of 9.52% in the trailing four quarters.

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