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.
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
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 C4ISR
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
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 driver
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 intelligence
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 materials.
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 Finmeccanica SpA.
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
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., Singapore.
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
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 technology.
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 (Hold).
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
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
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