The U.S. is the world's largest aerospace and defense market,
and also home to the world's largest military budget. The
industry largely depends on U.S. government contracts. As such,
the outlook for the industry is closely tied to the outlook for
defense spending by the government. The spending component of the
ongoing budget debate and the 'Fiscal Cliff' is heavily weighted
towards the defense budget.
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Defense spending is the major source of revenue for the top nine
global aerospace and defense companies, with the US accounting
for more than 40% of total global defense spending. Given the
uncertain macroeconomic environment, not just in the U.S. but
also globally, the industry faces the risk of fewer new orders as
customers are more likely to postpone or cancel contractual
orders and/or payments.
In December this year, the U.S. Senate unanimously approved the
fiscal 2013 budget worth $633.3 billion. Of this, $527.5 billion
was allotted to fund basic national defense and the Energy
Department, $17.4 billion was for nuclear weapons projects and
$88.5 billion more for overseas operations.
Currently, the U.S. defense spending is negatively impacted by
the Budget Control Act of 2011. The Budget Control Act of 2011
has two main parts that would affect future defense spending. The
first part dictates a $487.0 billion reduction to
previously-planned defense spending over the next decade. The
second part is a sequester mechanism that would impose an
additional $500.0 billion of cuts on defense spending if Congress
is not able to reduce the U.S. deficit by $1.2 trillion by
January 2, 2013.
With just days to go before the deadline hits, the issue is as
uncertain now as it was immediately after the November elections.
While a 'grand bargain' doesn't appear to be on the table
anymore, a non-resolution of the 'Cliff' issue would be a major
blow to the aerospace industry. In fact, the Congressional Budget
Office expects the economy to slide into a recession if the
automatic spending cuts and tax increases associated with the
'Fiscal Cliff' are not averted.
Since the September 2001 WTC and Pentagon attacks, the U.S.
government has spent significant amounts on military campaigns
overseas. The country has already decided to gradually move out
of Afghanistan, and the war in Iraq has already ended, which is
expected to lower its expenditure on foreign campaigns. In
addition to budgetary constraints, including the Budget Control
Act, defense spending will come down with the draw-down of U.S.
force levels tied to current major overseas deployments.
Acquisition, Merger, Spin-offs and Strategic Alliances
The big defense operators armed with strong balance sheets are
expanding their operations inorganically through acquisitions.
The U.S. Defense department also endorses mergers among U.S.
defense companies, provided they don't involve the top five or
six suppliers acquiring each other. For that matter, the industry
encourages acquisitions as the highest-priority investment area
for a company with a sizeable cash balance looking for growth
amid significant defense budget cuts.
In fact, the four main strategies to stimulate that growth are
joint ventures, foreign military sales, international expansion
and mergers and alliances.
Lockheed Martin Corporation
) announced the acquisition of Chandler/May Inc., an unmanned
aerial systems manufacturer. Lockheed Martin's prudent
acquisition of Chandler/May would expand its expertise in the
design, development, integration, manufacturing and support of
fully integrated mission critical systems for unmanned aerial
systems ("UAS") and Command, Control, Communications, Computers,
Intelligence, Surveillance, Reconnaissance ("C4ISR") missions.
Lockheed would leverage the expertise of Chandler/May Inc. to
carry out the October contract for Coast Guard Super Hercules
The Boeing Corporation
) recently completed the acquisition of Miro Technologies. Miro
is a privately held software company that specializes in
enterprise asset and supply chain management; MRO services; and
Performance-Based Logistics ("PBL") management for government and
commercial customers worldwide. This acquisition would bolster
the company's defense logistics support strategies. Prior deals
made by the company include acquisition of Tapestry Solutions,
Federated Software Group, and CDM Technologies.
In December this year,
General Dynamics Corporation
) completed the acquisition of Applied Physical Sciences Corp. of
Groton, Connecticut. Applied Physical Sciences is a leading
provider of applied research and development services. It will
become a part of General Dynamics Electric Boat and help in
various engineering programs.
Again in December,
) completed the acquisition of the Government Solutions business
of SafeNet Inc. for an undisclosed amount. The need for acquiring
a privately held data security firm comes in the light of
supporting the U.S. government's growing need for protected and
encrypted data. In October 2012, Raytheon had also completed the
acquisition of Teligy, Inc. that has improved the company's
cybersecurity offerings in wireless communications, vulnerability
analysis, reverse engineering and custom kernel software/device
Northrop Grumman Corporation
) completed the acquisition of M5 Network Security Pty Ltd.
Australia-based M5 Network Security is a provider of
cybersecurity and secure mobile communications products and
services, and advanced analytics to Australian military and
These acquisitions help the defense pros in fulfilling task
orders and contracts. For instance, in December 2012, Raytheon
received a contract to develop new techniques to perform research
and develop tools to integrate new and individual facts into
existing large information stores. In this case, the company
would be helped by the acquisition of SafeNet Inc. The acquired
unit would help the company in performing this task order while
maintaining its relationship with various customers.
Agreements and Contracts
In the light of defense budget cuts and risks to high-budget
programs, the companies often fall back on joint ventures and
strategic alliances to pool their resources giving them access to
new markets. Moreover, these alliances help to cut down on
competition in a densely competitive space.
Sometimes two aerospace companies that are in a strategic
alliance benefit from a single contract. Boeing and
) together recently received a contract from the U.S. Marine
Corps for seven Osprey ground-based trainers, which will reduce
fuel usage and aircraft wear-and-tear, maximizing lifecycle cost
savings. In this case both the parties were benefited.
Also, aerospace majors are known to venture beyond the pale of
their universe to find future aerospace solutions. These domestic
and international agreements are made to bring in new technology
and expertise. In November this year, Lockheed Martin had signed
a three-year agreement under the Department of Defense ("DoD")
Mentor-Protégé Program. Per the agreement, Lockheed will assist
IERUS Technologies in further developing its government contract
accounting system, quality and procurement processes and export
In December this year, Boeing signed a collaboration agreement
with BMW Group as per which they will make a joint research on
carbon fiber recycling. Moreover, they will also share
information about carbon fiber materials and manufacturing. This
would allow Boeing to develop the use and end use of carbon fiber
Then there are international agreements that are done in order to
bring in new technology and expertise. In September this year,
Boeing entered into an agreement with Sojitz Corporation, a
Japanese company. Per the agreement, Boeing will provide training
to support Japan's need for more cybersecurity experts. In turn,
Sojitz will contribute its Japanese market expertise, information
technology professionals and strong local partnerships.
To respond to anticipated requests for both the new U.S. Air
Force Combat Rescue Helicopter and the U.S. Navy's recently
announced program to develop a new "Marine One" presidential
helicopter, Northrop Grumman entered into an agreement with
In November this year, General Dynamics received a contract
modification from the government of Canada for the upgrade of 66
more LAV III vehicles. Meanwhile
Huntington Ingalls Industries
) in December received a cost-plus-fixed-fee contract to provide
life-cycle engineering and support services for USS San Antonio
(LPD 17) class of amphibious transport docks of the U.S. Navy.
The contract is the third of the four annual options that was
associated with a base contract awarded in February 2010.
These types of contract modifications and execution of options
indicate the U.S. Navy's as well as other federal bodies'
confidence in the aerospace and defense companies.
The aerospace and defense companies generate revenue from
international orders and foreign military sales ("FMS"). With a
continually challenged domestic defense sector and decline in
contracts from the U.S. government, the industry remains focused
on international growth. Foreign sales of U.S. military aircraft
provide an important growth area. Currently, the C-17, F-15 and
F-16 have huge international export demand.
The rapidly evolving security challenges and the need for
countries to modernize aging inventories keep demand alive in
international markets. However, in Europe, the continuous
financial crisis is forcing governments to institute austerity
measures that will negatively impact defense spending in the near
term. The initiatives taken up would constrain their defense
budgets and fiscal priorities in current and future periods.
Over the next few years, demand for U.S. military exports is
expected to remain strong. A truculent Iran, with increasing
potential for nuclear capacity and relatively strong oil prices,
has of late spurred the demand for U.S. military aerospace
products by Gulf countries. Similarly, increasing Chinese defense
budgets have led to significant, new U.S. sales in South and East
Asia. Going forward, these sales would more than offset
diminishing sales to European countries that have significantly
cut their defense budgets.
In November this year, Northrop Grumman announced that it will
supply advanced shipboard navigation systems for 20 fast patrol
vessels under a contract with Indian reseller Marine Electricals
Ltd. The systems will be supplied to Indian Coast Guard. Then in
September this year, Northrop Grumman received a contract to
supply navigation bridge equipment for a series of 39,500-dwt dry
bulk cargo ships from China Navigation Company Pte. Ltd.,
In November this year, Raytheon has received a contract from the
Kingdom of Saudi Arabia to deliver a Command, Control,
Communications, Computers and Intelligence (C4I) system.
Recently, in December, Lockheed has received an FMS contract to
support integration of the Joint Air-to-Surface Standoff Missile
("JASSM") onto the Finnish Air Force ("FiAF") F-18C/D aircraft.
Cutting-Edge Innovation and New Products
At the macro level, a gradual shift in defense spending patterns
can be discerned. In response to asymmetric terrorist threats,
the emphasis appears to have shifted to high-tech intelligence
equipment, replacing demand for conventional big guns and heavy
armor. The major industry players have, in response, resorted to
bolt-on acquisitions to plug gaps in their product offerings.
Among state-of-the-art products, the latest radar and
telecommunication systems, new ballistic missiles, unmanned
warplanes, development of fighter jets and sophisticated
surveillance equipment are on the priority list of most
countries. These help enhance the preparedness of a nation to
detect, preempt and counter hostile situations.
Contemporary warfare has seen a paradigm shift from traditional
forms of waging a war. There is high demand for new defense
products that help the military in locating and eliminating
terrorists before they strike.
The aerospace and defense industry is experiencing continued
consolidation. The companies are also busy restructuring in order
to streamline their operations. Lockheed Martin announced such a
restructuring in October this year which would enhance customer
The other way out for U.S. weapon makers who are under pressure
to cut costs and preserve profit margins amid dwindling defense
spending in the U.S is layoffs. Recently, Boeing reduced the
number of defense executives by 30% from 2010 levels, closed
facilities in California and consolidated several business units
to cut costs. After almost completing work on special armor for
military vehicles and a decline in demand for its guns, General
Dynamics has also decided to lay off about 50 employees in
Vermont and 30 in Maine.
Closure of the F-22 production line and decisions not to fund
additional C-17 transport purchases or development of a future
strategic lifter cast a negative impact on the industry. However,
the F-35 Joint Strike Fighter program, the KC-46 tanker, the P-8
maritime patrol aircraft and other platforms continue to receive
Meanwhile, Northrop Grumman is also planning to cut up to 350
jobs from its electronics systems sector, with most of the
reductions likely in the Baltimore area. These companies are also
contemplating additional layoffs.
The global economic downturn that started in late 2008 has
significantly weakened the financial profiles of all major
industrialized countries. The growth and development of the
aerospace and defense industry is tied to the defense budgets of
the different nations around the globe, especially the U.S. The
general trend in this context is to cut national defense
The major defense spenders throughout the world are on an
austerity drive. They are gradually lowering their defense
budgets and concentrating on other avenues to fix their ailing
economies. 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.
Acquisition and Program Risk
Taking into account the huge number of acquisition deals, the
industry faces risks associated with the completion, integration,
and financing of these acquisitions. Then with the majority of
revenue coming from government contracts, the industry could be
adversely affected by the cancellation and delay of major
Going forward, regulatory and legislative pressures are the most
significant barrier to growth. Besides, energy prices and a lack
of consumer demand could act as obstacles to the growth curve.
The aerospace and defense companies compete amongst themselves in
the information and services markets for a number of small and
large programs. The major defense players are Boeing, Raytheon,
), BAE Systems plc, European Aeronautic Defense and Space Company
EADS N.V., Finmeccanica SpA, Airbus,
) and Bombardier Inc. In addition, Canada, China, Japan and
Russia are all making efforts to enter or re-enter the large
civil aircraft market. Therefore, with new competitors coming in,
it has become important for the U.S. pros to stay ahead in
Earnings Review and Zacks Rank
The Zacks Industry Rank, which relies on the same estimate
revisions methodology that drives the Zacks Rank for stocks,
currently puts the aerospace industry at 101 out of 259
industries in our expanded industry classification, broadly
qualifying the industry in the Neutral category. None of the 16
companies in the aerospace industry has the coveted Zacks Rank #1
(Strong Buy). However, 2 have Zacks Rank #2 (Buy), 1 has a Zacks
Rank #4 (Sell) rating and the remaining 13 hold a Zacks Rank #3
The majority of stocks in the aerospace industry, such as Boeing,
General Dynamics, Raytheon, Lockheed,
Rockwell Collins Inc.
), L-3 Communications, Northrop, Huntington Ingalls Industries,
MTU Aero Engines Holding AG, Safran SA,
Wesco Aircraft Holdings, Inc.
), Embraer SA, European Aeronautic Defense and Space Company,
presently retain a Zacks #3 Rank (Hold). However, we have
Alliant Techsystems Inc.
Erickson Air-Crane Incorporated
) on the Zacks #2 Rank (Buy) list, with Textron at Zacks Rank #4
The earnings results of Boeing, Raytheon, Lockheed, Rockwell
Collins, L-3 Communications and Northrop surpassed the Zacks
Consensus Estimates. The highest positive surprise of 46 cents
came from Lockheed, while General Dynamics and Textron missed
expectations. Overall, total aerospace industry earnings were
down 3.3% in the third quarter, but are expected to be down 16.9%
in the fourth quarter. For full-year 2013, the industry is
expected to see a modest earnings growth of about 1.1%.
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 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. To maintain this
important sector of the U.S. economy, the U.S. Commercial Service
strives to provide assistance to increase the industry's
The U.S. aerospace industry continues to contribute significantly
to the country's economy and provides capabilities vital for
national security. It generates new technology in fields such as
advanced materials, sensors, information processing and sharing.
Finally, aerospace continues to generate the largest positive
trade balance of any U.S. manufacturing sector.
The U.S. is the leader in global defense spending. The major
super power also has strategic alliances in place with other
foreign nations with considerable military strengths. The country
shares its military technology and supplies sophisticated weapons
to its allies. These activities, in turn, boost the revenue of
the defense operators.
However, on the flip side, the costs for executing projects for
the aerospace and defense companies due to order delays would
increase leading 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.
Moreover, in the forthcoming years, the industry will face
challenges, particularly in the defense sector, as the federal
government looks for solutions to an ongoing budget crisis.
Sequestration is creating uncertainty in both the civil and
Despite the uncertainty related to sequestration, huge defense
budget cuts and cancellation of big-ticket programs, we have a
mixed outlook for the sector based on product progress,
opportunities, acquisition benefits and cost-cutting efforts of