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Passenger Growth, Trade Surplus Aid Aerospace-Defense Players

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The Zacks Aerospace-Defense industry comprises companies that primarily design and manufacture heavy-built products like commercial as well as military jets and helicopters, tankers and other combat vehicles, missiles, combatant ships as well as auxiliary ships, submarines, bombs, guns, space transportation vehicles, military satellites and a few more.

The industry also includes cyber security players that offer information technology (IT) services and C4ISR (command, control, communications, computers, intelligence, surveillance and reconnaissance) solutions.

A portion of revenues comes from defense contractors offering spare parts, aircraft modification, ship repair and overhaul services and supply chain management services.  Some of the prominent stocks in this industry are Huntington Ingalls Industries (HII - Free Report) , L3Harris Technology (LHX - Free Report) , Northrop Grumman (NOC - Free Report) , Boeing (BA - Free Report) and Textron (TXT - Free Report) .

Here are the three major industry themes:

  • A steady improvement in global air traffic has pushed up commercial airplane demand, thereby providing an impetus to the U.S. Aerospace and Defense industry. Per the latest forecast made by the International Air Transport Association (IATA) in June 2019, global air passenger numbers are expected to rise to 4.6 billion in 2019 from 4.4 billion in 2018. Meanwhile, Boeing, the largest jet maker, expects that the world will need 44,040 new planes, worth $6.8 trillion, over the next 20 years. The new outlook indicates a 6.7% improvement from the company’s previous 20-year outlook. The improved projection is based on strong air-traffic trends in the emerging markets of Asia-Pacific, along with established markets of Europe and North America. Increasing jet demand is expected to drive the aviation services market. To this end, Boeing expects commercial aviation services market to grow 4.2% annually, thereby reaching a value of $9.1 trillion by 2038. Thus, the short as well as long-term growth prospects of U.S. aerospace-defense stocks seem bright.
     
  • With the United States being the largest supplier of defense products, it is undoubtedly a golden era for the nation’s aerospace and defense stocks. U.S. defense majors are expanding their foreign markets rapidly, particularly taking advantage of regional tensions prevailing in the Middle East lately. According to the latest report from Aerospace Industries Association (AIA), the U.S. Aerospace and Defense industry generated $151 billion in exports and a solid trade surplus of $89.5 billion in 2018. Notably, the industry is currently the nation’s leading net exporting industry. With no indication of the global geopolitical unrest coming to an end anytime soon and nations like Japan and India raising their defense budgets significantly, the winning streak for these stocks is expected to continue in the near term.
     
  • The industry struggled with retirements and a shortage of trained technical graduates over the last decade. However, a reversal of this trend has been noticed lately. Per a recent report by AIA, in 2018, the U.S. aerospace and defense industry supported over 2.5 million American jobs up and down the supply chain, a 3.7% increase from the previous year. This reflects a stark improvement from 1.6% decline in employment in the last five years up to 2017. It seems like the labor shortage issue has been addressed, at least for the near term.

Zacks Industry Rank Indicates Encouraging Prospects

The Zacks Aerospace-Defense industry is housed within the broader Zacks Aerospace sector. It currently carries a Zacks Industry Rank #20, which places it in the top 8% 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 an optimistic 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 over the past few months. Evidently, the industry’s loss estimates for the current fiscal year have gone down 23.2% to $8.66 since April 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, Lags Sector

The Aerospace-Defense industry has outperformed the Zacks S&P 500 composite but underperformed its own sector over the past year. The stocks in this industry have collectively inched up 0.2%, while the Aerospace sector has gained 1.4%. The Zacks S&P 500 composite has however slipped 0.5% in the said timeframe.

One-Year Price Performance

Industry’s Current Valuation

On the basis of trailing 12-month EV/Sales ratio, which is used for valuing capital intensive stocks like aerospace-defense, the industry is currently trading at 1.77 compared with the S&P 500’s 2.94 and the sector’s 1.62.

Over the past five years, the industry has traded as high as 1.85X, as low as 1.25X, and at the median of 0.90X, as the charts show below.

EV-EBITDA Ratio (TTM)

Bottom Line

Although the rise in employment has brought about a near-term improvement, its sustenance will be essential in maintaining the U.S. aerospace and defense industry’s position as a world leader. Meanwhile, the budget proposals from Pentagon, under Trump’s administration, reflect hawkish spending provisions for the U.S. Department of Defense. This along with impressive growth trends projected for the global air passenger growth is expected to drive the industry in the near term.

Given the industry’s favorable rank, investors may bet on a few stocks in this space that exhibit a strong earnings outlook.

We are presenting three aerospace-defense stocks with a Zacks Rank #2 (Buy) that investors may want to add to their portfolio. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Lockheed Martin Corp. (LMT - Free Report) : For this Bethesda, MD-based company, the Zacks Consensus Estimate for 2019 EPS indicates year-over-year improvement of 20.6%. It came up with average positive earnings surprise of 16.03% in the trailing four quarters.

General Dynamics Corp. (GD - Free Report) : For this Falls Church, VA-based company, the Zacks Consensus Estimate for 2019 EPS indicates year-over-year improvement of 5.9%. It came up with average positive earnings surprise of 4.85% in the trailing four quarters.

Leidos Holdings, Inc. (LDOS - Free Report) : For this Reston, VA-based company, the Zacks Consensus Estimate for 2019 EPS indicates year-over-year improvement of 8.2%. It came up with average positive earnings surprise of 6.51% in the trailing four quarters.

 

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