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Mergers Boost Aerospace-Defense Equipment Near-Term Prospects

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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 activities to defense players.

Here are the three major industry themes:

  • While rising competition has frequently prompted industry bigwigs to expand their product lines through small and medium sized 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. Speaking of big mergers, missile-maker Raytheon RTN inked an all-stock merger deal with multinational conglomerate United Technologies UTX this June. Considered to be the biggest merger in the U.S. aerospace and defense space, this deal is expected to generate a conglomerate worth $121 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 frequent 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, reaching a value of $132.26 billion, with North America dominating the market. This should further boost 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 national security. An affirmation 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. The final decision concerning this investigation is still pending. The outcome might result in imposition of import tariffs and 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 currently carries a Zacks Industry Rank #63, which places it in the top 25% 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 June 2019.

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 13.7%, while the Aerospace sector has gained 8.1%. However, the Zacks S&P 500 composite has slipped 0.6% 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 2.39X compared with the S&P 500’s 2.90X and the sector’s 1.61X.

Over the past five years, the industry has traded as high as 2.42X, as low as 1.32X, and at the median of 1.76X, as the charts show below.

EV-Sales Ratio (TTM)

Bottom Line

The fiscal 2020 budget indicates 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.

Although possible imposition of tariff on import of titanium sponge remains a concern, considering the industry’s favorable industry rank and price performance history, investors may bet on a few stocks from the 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.

Transdigm Group (TDG - Free Report) : The Zacks Consensus Estimate for this Cleveland, OH-based company’s current year earnings indicates year-over-year improvement of 0.9%. It came up with average positive surprise of 10.71% in the trailing four quarters. It sports a Zacks Rank #1.

Teledyne Technologies (TDY - Free Report) : For this Thousand Oaks, CA-based company, the Zacks Consensus Estimate for current-year EPS indicates year-over-year improvement of 12.1%. It came up with average positive surprise of 9.26% in the trailing four quarters. It also sports a Zacks Rank #1.

HEICO (HEI - Free Report) : For this Hollywood, FL-based company, the Zacks Consensus Estimate for fiscal 2019 EPS indicates year-over-year improvement of 25.97%. It came up with average positive surprise of 10.07% in the trailing four quarters. It carries a Zacks Rank #2.

Hexcel (HXL - Free Report) : For this Stamford, CT-based company, the Zacks Consensus Estimate for current-year EPS indicates year-over-year improvement of 15.4%. It came up with average positive surprise of 3.91% in the trailing four quarters. It also carries a Zacks Rank #2.

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