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3 Defense Equipment Stocks to Watch Amid Poor Air Traffic View

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New travel restrictions in the wake of the highly transmissible Omicron variant have once again made the near-term outlook for air travel trends dismal. Moreover, COVID-led supply chain disruption might result in lower earnings and cash flows for the industry. This may hurt the growth prospects of the stocks in the Aerospace-Defense Equipment industry. Nevertheless, frequent mergers and acquisitions tend to boost revenue generation prospects along with the production efficiency of the industry players. Moreover, the latest feud that has erupted between Russia and Ukraine is expected to boost investment in the industry. Some important players in this industry include TransDigm Group TDG, Aerojet Rocketdyne AJRD and Kaman Corporation KAMN.

About the Industry

The Zacks Aerospace-Defense Equipment industry comprises firms that manufacture a wide variety of 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. A few of these companies also offer integrated simulation and training services to the U.S. defense force. While the majority of the revenues is 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 small and medium-sized mergers and acquisitions (M&As) besides some big mergers witnessed in the industry. In November 2021 , Raytheon completed the acquisition of SEAKR Engineering, a supplier of advanced space electronics. The transaction is expected to boost Raytheon’s Space business opportunities. This deal adds to Raytheon’s earlier made FlightAware buyout, which strengthened RTX’s footprint in the flight data monitoring market. Such consolidations should improve economies of scale for the industry as a whole with the industry players having access to such diversified business models.

Poor Air Traffic View Hurts Prospects: Although optimism surrounding the arrival and initial distribution of vaccine instilled confidence among travelers over the last few months of 2021, world air travel data once again dwindled at the onset of 2022. In fact, the International Air Transport Association (IATA) revealed in its January 2022 report that global air travel started 2022 on a soft note. The Omicron outbreak resulted in new travel rules that negatively impacted passenger capacity and demand. Per the report, developments in international ticket sales suggest that international travel will be affected more than domestic routes by the Omicron wave, at least in the near term. This surely makes us skeptical about the near-term growth prospects of aerospace-defense equipment industry stocks.

Socio-Political Uncertainty to Aid: Widespread geopolitical as well as socio-economic tensions have been a growth driver for the aerospace and defense equipment industry for decades. In the recent times, escalating international terrorist attacks along with civil wars like the ones in the Middle East have been boosting the prospects of this space. In particular, U.S. defense contractors’ prospects in this region remain high, thanks to the constant military conflict that has been taking place between Israel and Syria for quite some time now. Moreover, the latest feud that erupted after Russia attacked Ukraine and the United States’ strong opposition to this hostile action of Russia boosts the prospects of America’s defense companies. Such geopolitical tensions are expected to be beneficial for the aerospace-defense equipment industry.

Supply Chain Disruption Poses Risk: The COVID-19 pandemic has led to an unprecedented crisis in the aerospace and defense (A&D) 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 result in lower earnings and cash flows for the aerospace and defense equipment industry in the near term.

Zacks Industry Rank Reflects Bleak Outlook

The Zacks Aerospace-Defense Equipment industry is housed within the broader Zacks Aerospace sector. It currently carries a Zacks Industry Rank #169, which places it in the bottom 33% 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 dull 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. Evidently, the industry’s earnings estimate for the current fiscal year has gone down 3.3% to $3.77 since November 2021.

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 Beats S&P 500 & Sector

The Aerospace-Defense Equipment industry has outperformed the Zacks S&P 500 composite as well as its own sector over the past year. The stocks in this industry have collectively gained 10.5% against the Aerospace sector’s decline of 15.9%. The Zacks S&P 500 composite has risen 10.4% 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 2.42X compared with the S&P 500’s 3.97X and the sector’s 1.88X.

Over the past five years, the industry has traded as high as 2.68X, as low as 2.25X, and at the median of 2.47X, as the charts show below.

EV-Sales Ratio TTM

3 Aerospace-Defense Equipment Stocks to Watch

Aerojet Rocketdyne: Based in El Segundo, CA, Aerojet Rocketdyne is a technology-based engineering and manufacturing company, which develops and produces specialized propulsion systems as well as armament systems. In February 2022, Aerojet announced that it had successfully built and tested a Stored Chemical Energy Propulsion, a lithium boiler that could be used to power the U.S. Navy’s next-generation torpedoes. Aerojet Rocketdyne is also developing SCEPS for the larger MK 54 MOD 2 torpedo. Such developments should boost Aerojet’s order growth possibilities from the U.S. Navy.

The Zacks Consensus Estimate for Aerojet’s 2022 earnings indicates a 5.1% improvement year over year while that for sales projects an increase of 4.1%. The company currently carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price & Consensus: AJRD

Transdigm Group: Based in Cleveland, OH, Transdigm Group’s diversified portfolio of highly engineered proprietary aerospace components enjoys solid demand in the aircraft market. The company recently reported its first-quarter fiscal 2022 results, wherein its net sales increased a solid 7.8% year over year, while adjusted earnings increased 54%.

The Zacks Consensus Estimate for fiscal 2022 earnings implies an improvement of 30.8% year over year. Its long-term earnings growth estimate is pegged at 22.2%. The company currently holds a Zacks Rank #3 (Hold).

Price & Consensus: TDG

Kaman Corporation: Bloomfield, CT-based Kaman produces and markets proprietary aircraft bearings and components; super precision, miniature ball bearings, proprietary spring energized seals, springs and contacts; complex metallic and composite aerostructures for commercial, military and general aviation fixed and rotary wing aircraft; and safe and arming solutions for missile and bomb systems for the U.S. and allied militaries. The company recently reported its 2021 results, wherein its gross margin increased more than 200 basis points to 33.4%, driven by improved performance in several of its businesses.

The Zacks Consensus Estimate for Kaman’s 2022 earnings suggests an annual improvement of 14.2%, while that for 2022 sales indicates an increase of 5.4%. The company currently has a Zacks Rank #3.

Price & Consensus: KAMN

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Transdigm Group Incorporated (TDG) : Free Stock Analysis Report

Kaman Corporation (KAMN) : Free Stock Analysis Report

Aerojet Rocketdyne Holdings, Inc. (AJRD) : Free Stock Analysis Report

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