3 Defense Equipment Stocks to Buy as New Acquisitions Raise Hopes
Total airline revenues are expected to recover to around 93% of the 2019 figure, with operating profits reaching $22.4 billion, as predicted by International Air Transport Association ("IATA"). This bolsters the growth prospects of aerospace-defense equipment stocks, especially those involved in commercial aerospace. However, COVID-led supply chain disruption might hurt the earnings and cash flows of industry players. Also, rising jet fuel prices put pressure on airlines, which, in turn, may hurt aerospace-defense equipment stocks. Frequent mergers and acquisitions tend to boost the revenue-generation prospects of industry participants. Some key players in this industry that you may keep in your portfolio include TransDigm Group TDG, Bae Systems BAESY and Curtiss-Wright CW.
About the Industry
The Zacks Aerospace-Defense Equipment industry comprises firms that manufacture various vital components for the aerospace-defense space, ranging from aerostructures, space shuttles, propulsion systems, aircraft engines, defense electronics, missile and radar systems to flight test equipment, structural adhesives, instrumentation and control systems, communication products and many more. Some of these companies also offer integrated simulation and training services to the U.S. defense force. While majority of the revenues are generated from the production of the aforementioned accompaniments, the industry players also generate revenues by providing notable aftermarket support and services like maintenance, repair and overhaul activities to aerospace and defense players.
4 Trends Shaping the Future of the Aerospace-Defense Equipment Industry
New M&As Instill Hopes: Rising competition has historically prompted industry majors to expand their product lines through smal-l and medium-sized mergers and acquisitions (M&As) apart from the big mergers in the industry. In May 2023, Heico Corp.declared its intent to acquire Wencor Group. Wencor Group, which boasts a strong portfolio of products in the aftermarket space and serves varied airlines worldwide, aircraft maintenance repair and overhaul companies, military agencies and defense contractors. The acquisition will thus provide HEICO an opportunity to expand its customer base, enhance its product offerings and increase its market share in the aftermarket jet service business area. In March, AAR Corp. completed the acquisition of the aircraft maintenance, repair and operation and fleet management software provider, Trax USA Corp., for $120 million. This buyout is projected to expand AIR’s offerings in digital solutions for its core aviation aftermarket customers.Such consolidations should improve economies of scale for the industry as a whole, with the players having access to diversified business models.
Recovering Air Traffic View Boosts Prospects: World air travel data has been on a steady growth trajectory for the past few months. Per the latest report published by IATA in June 2023, the airline industry is forecast to return to profitability in 2023, only three years after the historic loss of $140 billion in 2020. Total airline revenues are expected to recover to around 93% of the 2019 figure, with operating profits reaching $22.4 billion. This, in turn, should benefit aerospace-defense equipment industry stocks, especially those engaged in commercial aviation.
Unusual Strength of the Dollar Remains a Concern: Global inflation rose to 8.7% in 2022 and is likely to pull back to 7% in 2023. This leaves the price level higher, although may be at a somewhat slower pace, but is still rising. A stronger U.S. dollar puts pressure on airlines on top of high inflation and high jet fuel prices. This is because U.S. dollar-denominated costs rise for all businesses whose revenues are in another currency. An appreciated U.S. dollar value is a risk for aerospace-defense equipment stocks, particularly the ones in commercial aerospace, considering the fact that the share of jet fuel in airlines’ operating costs is considerably high, between 25% and 30%.
Supply Chain Disruption Poses Risk: The COVID-19 pandemic has led to an unprecedented crisis in the aerospace and defense supply chain. Original Equipment Manufacturers (OEMs) need to dramatically scale back their capacity to reflect the new realities of the commercial air travel market. Such OEM rate reductions have been affecting the extended commercial aerospace manufacturing supply chain, which might lower earnings and cash flows for the aerospace and defense equipment industry in the near term.
Zacks Industry Rank Reflects Bright Outlook
The Zacks Aerospace-Defense Equipment industry is housed within the broader Zacks Aerospace sector. It currently carries a Zacks Industry Rank #170, which places it in the bottom 32% 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 bottom 50% of the Zacks-ranked industries is due to a negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts have lost confidence in this group’s earnings growth potential over the past few months. The industry’s earnings estimate for the current fiscal year has gone down 9.4% to $3.74 since Jan 31.
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 Lags S&P 500, Beats Sector
The Aerospace-Defense Equipment industry has underperformed the Zacks S&P 500 composite but outperformed its sector over the past year. The stocks in this industry have collectively gained 8.1%, while the Aerospace sector has increased 2.6%. The Zacks S&P 500 composite has surged 11.6% in the same timeframe.
One-Year Price Performance
Industry's Current Valuation
On the basis of trailing 12-month EV/Sales, which is used for valuing capital-intensive stocks like aerospace-defense equipment, the industry is currently trading at 2.38X compared with the S&P 500’s 3.52X and the sector’s 2.16X.
Over the past five years, the industry has traded as high as 2.54X, as low as 2.15X, and at the median of 2.37X, as the charts show below.
EV-Sales Ratio TTM
3 Aerospace-Defense Equipment Stocks to Buy
TransDigm Group: Based in Cleveland, OH, TransDigm Group is a leading global designer, producer and supplier of highly-engineered aerospace components used in commercial and military aircraft. In May 2023, the company announced its second-quarter fiscal 2023 results. Its fiscal second-quarter net sales improved 20% year over year, while earnings per share from continuing operations rose 57%.
The Zacks Consensus Estimate for TransDigm’s fiscal 2023 earnings indicates a 40.2% improvement from fiscal 2022’s estimated figure. The Zacks Consensus Estimate for TDG’s fiscal 2023 sales suggests an improvement of 19.5% from the fiscal 2022 estimated figure. The company currently carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
Price & Consensus: TDG
Bae Systems: Based in Farnborough, United Kingdom, Bae Systems is an international defense, aerospace and security company that delivers a full range of products and services for air, land and naval forces and advanced electronics, security, information technology solutions and customer support services. In June 2023, Bae Systems announced that the forward end of HMS Cardiff warship has emerged from its ship build hall at Govan for the first time in an important moment for the program to deliver the most advanced anti-submarine warfare capability available to the Royal Navy. The company has completed all major units of the ship and expects the ship to float off in 2024.
The Zacks Consensus Estimate for BAESY’s fiscal 2023 sales implies an improvement of 25% from the fiscal 2022 estimated figure. Its fiscal 2023 earnings estimate indicates a 7.4% improvement from the fiscal 2022 estimated figure. The company currently holds a Zacks Rank #2.
Price & Consensus: BAESY
Curtiss-Wright: Davidson, NC-based Curtiss-Wright is a diversified multinational company, which provides highly-engineered products and services for high-performance platforms and critical applications in key areas such as commercial aerospace and defense electronics, reactor coolant pumps for next-generation nuclear reactors and advanced surface treatment technologies. In May 2023, the company announced that its board of directors has approved a 5% increase in the quarterly dividend to 20 cents per share, payable Jul 5, 2023, to stockholders of record as of Jun 16, 2023.
The Zacks Consensus Estimate for CW’s 2023 earnings suggests an improvement of 8.5% from 2022 reported figure. Its fiscal 2023 sales estimate indicates a 5.5% improvement from the fiscal 2022 estimated figure. The company currently has a Zacks Rank #2.
Price & Consensus: CW
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Transdigm Group Incorporated (TDG) : Free Stock Analysis Report
Bae Systems PLC (BAESY) : Free Stock Analysis Report
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