Aerospace & Defense Industry Outlook - December 2016
The outlook for the Aerospace has notably improved following the election on hopes that the incoming administration will stick to its campaign promise of ramping up military spending.
The incoming Trump administration hasn’t spelled out its plans yet, but that hasn’t stopped many Aerospace industry stocks from making big gains since November 8th. Stocks in the Zacks Aerospace sector (a stand-alone sector) were up +4.1% from the start of the year through November 8th, just a shade below the S&P 500 index’s +4.6% gain in that same time period. Since the election, however, the sector has gained +7.8% vs. the S&P 500’s +5%.
Increasing terrorist attacks across the globe have spurred nations to make heavy investments in their aerospace and defense industry. Some say it’s a ‘game for power,’ while others say it’s just a ‘protective measure.’
In a big-picture sense, the aerospace and defense industry is a direct beneficiary of a volatile and uncertain geopolitical global backdrop, characterized by terrorist threats, civil wars and border disputes. The U.S., home to the world’s major weapons manufacturers, is potentially a big beneficiary of this environment.
U.S. Defense Scenario
Apart from enjoying the lead in terms of economic prosperity, the U.S. has literally turned itself into a hub of aerospace and defense equipment and allied products over last few years. Other countries, in like manner, are also spending on state-of-the art artillery, to stay privileged.
The need for this rapid evolution of advanced military weapons surfaced with the meteoric rise of the Islamic State of Iraq and Syria (ISIS), an organization that President Obama termed “the network of death.”
Moreover, other factors like rising demand for more fuel-efficient aircraft, the growing international market and increasing application of unmanned aircraft in warfare today are driving up sales in this sector.
Also, other statistics like the declining unemployment rate, a consistent expansion in consumer spending, recent rise in new business volumes pushing up manufacturing index were favorable.
As such, the entire U.S. economy gave a strong performance in the third quarter as positive contributions were realized from private inventory investments, exports accelerated and federal government spending increased. Real GDP grew at an annual rate of 3.2% in the third quarter compared with the 1.4% rise in the prior quarter.
Naturally, the time is ripe for significant expansion in the aerospace and defense industry, with these encouraging factors expected in the fourth quarter as well.
Budget Updates
On Feb 9, 2016, President Obama unveiled the Pentagon's fiscal 2017 (FY 2017) budget request that is intended to reshape spending priorities taking into account new and evolving challenges. The proposed budget of $582.7 billion for the Pentagon includes a base budget of $523.9 billion. This reflects a $2.2 billion increase over the FY 2016 enacted budget of $521.7 billion.
The budget also includes $58.8 billion in funding for the Pentagon’s separate war fund, the overseas contingency operations (“OCO”) fund, which almost the same as the FY 2016 enacted level of $58.6 billion. The combined request represents a total increase of $2.4 billion or less than 1% over FY 2016 enacted levels.
The budget proposal mainly addressed five key challenges: the threat of Russian aggression in Europe as well as that of China in the Asia-Pacific, North Korea to the U.S. and its Pacific allies, Iran’s influence against allies in the Gulf, and the ongoing fight against the Islamic State.
On the top of this, President-elect Donald Trump in his pre-election campaign proposed for more troop strength, i.e. to employ more soldiers as well as strengthen the nation’s nuclear and missile equipment. He proposed reducing reduction in the overseas defense budget, so that the nation’s allies share more of the financial burden for security rather than American taxpayers. Whether he will implement this or not, only time will tell.
Overall, it seems like Trump is in favor of increasing defense expenditures, which would boost prospects of defense companies, once he takes charge of the Oval Office in Jan 2017.
Zacks Industry Rank – Mixed Bag
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 257+ industries is that the outlook for the top one-third of the list (Zacks Industry Rank of #88 and lower) is positive, the middle 1/3rd or industries with Zacks Industry Rank between #89 and #176 is neutral while the outlook for the bottom one-third (Zacks Industry Rank #177 and higher) is negative.
The aerospace industry is one of the 16 broad Zacks sectors within the Zacks Industry classification. Aerospace is further sub-divided into three industries at the expanded level: aerospace/defense, aerospace/defense equipment and electric-military.
Aerospace/defense is positive with a Zacks Industry Rank #22. The Zacks Industry Rank for Electronics-military is #17 out of 257 industries, which puts it in a positive range. Aerospace/defense equipment with a Zacks Industry Rank #175 comes in at the middle or in the neutral territory of all Zacks industries.
Earnings Review and Outlook
Every fiscal year, no matter how constrained the funding picture, the Pentagon almost always gets its way. Despite headwinds, the aerospace and defense sector held up well in the third quarter. As of Dec 6, 2016, all the defense companies in the S&P 500 index have already come up with their third-quarter results. The earnings beat ratio (percentage of companies coming up with positive surprises) was at an impressive 80%, while the revenue beat ratio was trending at 50%.
Nevertheless, the earnings picture for the fourth quarter of 2016 looks impressive, while that for the full year is a bit dismal. The sector’s earnings are expected to improve 7.2% in the fourth quarter, while. revenues are expected to see a 1.4% rise. For 2016, the sector’s earnings will likely drop 0.8% (against a drop of 7% in 2015) while revenues are expected to witness 0.6% growth (versus 2.5% growth registered in 2015).
Further, in 2017, the sector’s earnings will likely improve 10.4% while revenues are expected to witness 2.2% growth.
Defense Stocks Worth Adding
Investors might keep a watch on the following utilities that have the financial strength to withstand a gradual increase in the interest rate without compromising on dividend payments.
Northrop Grumman Corp. (NOC) has a long-term earnings growth projection of 9.24%. This security stock registered positive earnings surprises in the last four quarters, with an average beat of 8.29%. Its 2016 earnings estimates moved up 6% in the last 60 days. Northrop currently sports a Zacks Rank #1 (Strong Buy).
Spirit AeroSystems Holdings, Inc. (SPR) has a long-term earnings growth projection of 50.71%. The defense stock surpassed estimates in three out of the last four quarters, with an average beat of 0.82%. Its 2016 earnings estimates moved up by 2.2% in the last 60 days. Spirit AeroSystems currently holds a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Our Best Private Investment Ideas
How would you like to see specific recommendations to capitalize on current market conditions?
Starting today, for the next month, you can follow all Zacks' private buys and sells in real time. Our experts cover all kinds of trades… from value to momentum . . . from stocks under $10 to ETF and option moves . . . from insider buys to companies that are about to report positive earnings surprises. You can even look inside exclusive portfolios that are normally closed to new investors. Click here for Zacks' private trades >>
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
SPIRIT AEROSYS (SPR): Free Stock Analysis Report
NORTHROP GRUMMN (NOC): Free Stock Analysis Report
To read this article on Zacks.com click here.
Zacks Investment Research
