Aerospace and Defense Industry Outlook - August 2013
The aerospace and defense industry found its largest base in the
U.S. with a military budget fittingly impressive. The country's
global leadership position requires it to maintain the capacity
to respond to the ever-changing national security environment.
In Apr 2013, the Obama administration proposed a defense budget
of $526.6 billion for FY14, down $0.9 billion from the FY13
annualized continuing resolution level of $527.5 billion.
However, the FY14 request does not yet include a detailed budget
for Overseas Contingency Operations ("OCO"), which is essentially
government-speak for foreign wars and war on terror operations.
The government is yet to release the OCO budget.
The budget calls for the termination of a few programs which
include C-17 Airlifter, F-22 stealth fighter, Future Combat
Systems, Multiple Kill Vehicle, Kinetic Energy Interceptor,
Airborne Laser, Combat search and rescue helicopter and
Budget Issues - the Sequester
The budget sequester that went into effect at the start of Mar
2013 and that has a direct bearing on the U.S. government's
defense spending is a function of the country's fiscal and
Per a media report released in June this year, the government has
provided details of $37 billion of sequestration cuts to occur by
Sep 30, 2013. These cuts will not spare any of the defense majors
from Lockheed Martin Corp. (
) to Huntington Ingalls Industries Inc. (
The Pentagon faces another $52 billion in reductions from planned
spending for the next fiscal year, if Congress and President
Barack Obama don't reach a consensus on reducing the U.S. budget
Offsetting the Sequestration Effect
Sequestration will cut some $1 trillion from the defense budget
over the next decade, according to The Washington Free Beacon.
Yet, the aerospace and defense industry is holding up well this
year thanks to technological innovations, big contracts,
acquisitions and growing commercial demand.
Since the domestic aerospace and defense sector is facing budget
cuts and a constrained spending environment, the industry is
looking for growth from international orders. Additionally, a
number of new emerging markets as well as developed nations, such
as India, Japan, the United Arab Emirates, Saudi Arabia and
Brazil, are boosting defense spending and generating business for
the U.S. aerospace and defense companies.
Moreover, these defense behemoths have diversified their
businesses to counter the effect of the sequester. Also, the
complex military programs being awarded to these companies much
before the across-the-board spending cuts came into force have
somewhat diluted the sequester impact.
The Zacks Industry Rank relies on the same estimate revisions
methodology that drives the Zacks Rank for stocks. The way to
look at the complete list of 260+ industries is that the outlook
for industries with Zacks Industry Rank of #88 and lower is
'Positive,' between #89 and #176 is 'Neutral' and #177 and higher
is 'Negative.' Zacks Industry Rank for the Aerospace industry is
at #69 out of 260 industries, which puts it in the Positive zone.
Please note that the Zacks Rank for stocks, which is at the core
of our Industry Outlook, has an impressive track record going
back years, verified by outside auditors, to foretell stock
prices, particularly over the short term (1 to 3 months).
Five of the nine companies in our coverage has a Zacks Rank #2
(Buy). While 3 carry a Zacks Rank #3 (Hold), one holds a Zacks
Rank #5 (Strong Sell).
European Aeronautic Defence and Space Company EADS N.V. (
), General Dynamics Corp. (
), Huntington Ingalls Industries, Lockheed Martin and Northrop
Grumman Corp. (
) carry a Zacks Rank #2 (Buy). While The Boeing Company (
), Erickson Air-Crane Incorporated (
) and Wesco Aircraft Holdings, Inc. (
) carry Zacks Rank #3 (Hold), Embraer SA (
) carries a Zacks Rank #5 (Strong Sell).
Earnings Review and Outlook
The second-quarter earnings season has been a testament to the
bullish trend in the defense sphere, defying sequestration and
budget cut woes. The earnings results of all the defense
companies in our universe except one surpassed the Zacks
The highest positive surprise of 43 cents came from Lockheed
Martin while the lowest surprise of 2 cents coming from Textron
). Embraer SA missed the Zacks Consensus Estimate by 23%.
As per our data, as of Aug 1, 2013, the top and bottom line
earnings beat ratio was 87.5% and 75%, respectively as compared
to 49.9% and 66.7%, respectively, for S&P 500 companies.
For a detailed look at the earnings outlook for this sector and
others, please read our weekly
Earnings Trends reports
The table below provides an outlook for the defense companies in
ALLIANT TECHSYS (ATK): Free Stock Analysis
BOEING CO (BA): Free Stock Analysis Report
ERICKSON AIR-CR (EAC): Free Stock Analysis
EMBRAER AIR-ADR (ERJ): Free Stock Analysis
GENL DYNAMICS (GD): Free Stock Analysis
HUNTINGTON INGL (HII): Free Stock Analysis
LOCKHEED MARTIN (LMT): Free Stock Analysis
NORTHROP GRUMMN (NOC): Free Stock Analysis
RAYTHEON CO (RTN): Free Stock Analysis Report
TEXTRON INC (TXT): Free Stock Analysis Report
WESCO AIRCRAFT (WAIR): Free Stock Analysis
To read this article on Zacks.com click here.
From Mar 1, 2013 to date, there have been a number of share price
gainers with Alliant Techsystems Inc. (
) witnessing the highest increase of 55.80% while Textron gaining
Alliant Techsystems with a Zacks Rank #1 (Strong Buy) witnessed a
positive earnings surprise of 16.67% this quarter and 15.68% over
the last four quarters. Strong results reflect increased profits,
lower interest expense, a lower tax rate and a decline in the
The company uses its cash in the best possible manner. Recently,
the company acquired Caliber Company, the parent company of
Savage Sports Corporation. The acquisition gives the company an
opportunity to bolster its leadership position in sporting and
security ammunition and accessories into the long guns market.
Apart from the company's cash deployment strategy, a continuous
in-flow of contracts and an order backlog of $1.4 billion make it
a Strong Buy.
Driven by operational improvements and capital deployment
actions, the earnings surprise this quarter for Raytheon Company
) was a positive 26.15%. Surprise over the last four quarters was
a positive 22.15%. Beginning Mar 1, 2013, the company's share
price has risen approximately 43%. Raytheon sports a Zacks Rank
#1 (Strong Buy).
Though the third quarter 2013 and full year 2013 estimates in the
table above depict a year-over-year decline, Raytheon looks good
with continuous in-flow of contracts, introduction of new
products, completion of flight test series, consolidation and
earnings beat to boot.
As of Jun 30, 2013, the company had a funded backlog of $22.2
billion that would convert into revenues in the near term. In
addition, the strong cash position, consistent dividend payment
and repurchase of shares make the stock look attractive. Indeed,
the company's strong cash position of $2.5 billion has been
helping it to acquire other firms. In June this year, the company
acquired Visual Analytics Inc. that will help the company in
meeting the data analytics, data visualization and information
sharing needs of its customers.
From Mar 1, 2013 to date, the company's share price has boosted
46.5%. It has delivered a positive earnings surprise of 20.59%
this quarter driven by a lower share count and strong operating
performance. The earnings beat over the last four quarters comes
A steady flow of contracts which also include international
orders, a funded backlog of $23.2 billion, introduction of new
products, and the tendency of returning wealth to its
shareholders drive this Zacks Rank #2 (Buy) stock.
Lockheed Martin, the foremost defense prime, experienced its
share price rise 42.2% since Mar 1, 2013. The positive surprise
was 19.46% in this quarter and 15.44% in the last four quarters.
Lockheed Martin with a Zacks Rank #2 (Buy) has a strong liquidity
position and utilizes the cash in the best possible manner via
dividends and share repurchases. Loaded with contracts, Lockheed
Martin is building three models of the F-35 for the U.S. military
and eight international partner countries including Britain,
Australia, Canada, Norway, Turkey, Italy, Denmark and the
Netherlands. Israel and Japan have also ordered the jet. Lockheed
Martin's F-35 program accounts for approximately 15% of the
company's revenue, which is expected to go up in the coming
Huntington Ingalls Industries
This company carrying a Zacks Rank #2 (Buy) ended the quarter
with a 21.74% positive surprise driven by solid program execution
at Ingalls Shipbuilding and Newport News Shipbuilding while it
posted a 7.71% positive surprise over the last four quarters on
average. Beginning Mar 1, 2013, the company saw its share
price soar 35.5%.
Good to Hold
The Boeing Company
Though the company carries a Zacks Rank #3 (Hold), we note that
it has surpassed the Zacks Consensus Estimate by 5.70% in this
quarter driven by solid operating performance fueled by higher
aircraft deliveries and lower 787 Dreamliner production costs.
Over the last four quarters, the company experienced a 12.87%
positive surprise on an average.
Despite various technical issues at its Commercial Airplane
Division, the company's share price seems to be shock resistant,
rising 38.70% from Mar 1, 2013. Backlog and deliveries are also
robust. Total Defense, Space & Security backlog was $51.5
billion as of Jun 30, 2013.
The company showed a negative earnings surprise of 23.08% this
quarter reflecting lower commercial aviation deliveries. It
experienced a 36.12% negative surprise over the last four
quarters on an average. The company's share price has also dipped
1.04% beginning Mar 1, 2013.
The company has a Zacks Rank #5 (Strong Sell) and is recommended
to be avoided for the time being.
Pros and Cons
Undeterred by defense budget cuts, the big defense operators are
expanding their operations through acquisitions. Moreover, in
order to counter the domestic headwinds, these players are
looking for growth from international orders and are busy
restructuring their businesses. Also, they are keeping themselves
abreast in the technological front with new products countering
The broad growth and development of the aerospace and defense
industry is tied to the defense budgets of different nations
around the globe, besides the U.S. The U.S. defense department
has reduced the defense budget significantly. These cutbacks will
impact the big contractors, as the lion's share of their revenues
comes from domestic defense spending. Moreover, with the majority
of revenue coming from government contracts, the industry could
be adversely affected by the cancellation and delay of major
government contracts. Again, with more and more acquisitions
being made by the defense players, there is always the risk of
completion, integration, and financing of these deals.
The aerospace & defense industry has been a keystone of the
U.S. economy for decades and has provided well paying jobs for a
variety of skill levels. The U.S. aerospace industry continues to
contribute significantly to the country's economy and provides
capabilities vital for national security.
However, on the flip side, the industry's position is now
challenged by global competition, changes in technology, national
and worldwide economic conditions, and global policies affecting
defense, civilian and commercial aviation.
Moreover, any delay in the execution of orders would lead to an
imbalance between the cost and revenue structure. This would not
only hurt profitability but also lead to delays and even
cancellations of orders and/or programs.
Sequestration still remains an overhang both in the civil and
military sectors. The companies that have little diversification
outside the U.S. are highly susceptible to spending cuts from
sequestration. On the other hand, those with an international
order book would find it less difficult to outwit sequestration.
Keeping in mind the solid earnings season, technological
progress, acquisition benefits and cost-cutting efforts of
individual companies, we have an overall bullish outlook for the