Will Defense be Hit by Weak Economies of Allied Nations? - Industry Outlook

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The sequester that went into effect at the start of Mar 2013 will cut spending by a total of approximately $1.1 trillion over the eight-year period from 2013 to 2021. This will likely affect the defense sector's performance. The recently approved defense spending bill for fiscal 2015 is $18 billion lower than the last fiscal year.

Defense Budgets in Allied Nations Under Pressure: A country's artillery expansion is determined by its economic growth. The faster the global economy grows, the higher the defense spending. Following the global crisis in 2008, there was a marked shift in defense spending growth from the developed to the emerging countries.

The European Commission, which is the executive arm of the EU, now expects the region's economy to grow at 0.8% this year and 1.1% next year, down from its late spring estimates of 1.2% and 1.7% for 2014 and 2015, respectively. In this context, a mature European defense market is indeed a challenge for the U.S. players.

Intense Competition: The aerospace and defense companies compete among themselves for a number of small and large programs. Therefore, with new competitors coming in, it is important for the U.S. pros to stay ahead in technology.

Given the looming headwinds, we advise investors against names that offer little growth/opportunity over the near term. These include companies for which estimate revision trends reflect a bearish sentiment.

We remain apprehensive on the Zacks Rank #4 (Sell) companies including Moog Inc. ( MOG.A ), Curtiss-Wright Corp. ( CW ), Ducommun Inc. ( DCO ) and L-3 Communications Holdings Inc. ( LLL ).

In addition, we are skeptical of these Zacks Ranked #5 (Strong Sell) stocks: American Science & Engineering Inc. ( ASEI ), Exelis Inc. ( XLS ), Kratos Defense & Security Solutions, Inc. ( KTOS ) and Wesco Aircraft Holdings, Inc. ( WAIR ).

Our Take

In " Defense Majors Step Up Foreign Sales to Weather Sequester ," we focused on the conditions which are expected to drive the industry forward.

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.

On the whole, budget austerities remain an overhang on the military sector. 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 combat sequestration.

Despite the uncertainty related to sequestration, huge defense budget cuts and cancellation of big-ticket programs, we have a mixed outlook for the sector on the back of technological progress, accretive acquisitions and cost-cutting efforts of individual companies. With careful management and prudent spending the sector is expected to weather the anemic defense budget environment. This keeps us for the most part neutral on the sector for the time being.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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