Aerospace and Defense are far from mature with innovation being the bedrock for this industry. I see only growth for those companies leading in this space. Over the past year, this industry’s equity prices have been up and down ending up close to flat for the year. I think that this underperforming industry has an enormous amount of potential for growth in 2019 as trade tensions lighten. Defense contracts being a hefty portion of revenues gives investors in this space a bit more security as well.
Boeing, the largest aircraft manufacturer in the world, was recently devastated by two Boeing 737 MAX crashes within five months, with the most recent accident on March 10th causing a 15% drop in stock price. There is still litigation concerning these crashes underway that may have a material effect on the stock price (if the 15% drop didn’t already price this in). This drop I believe has given investors a buying opportunity. Boeing has already made many steps to resolve any underlying issues with the aircraft and airlines like Southwest LUV, American AAL, and United UAL are still flying the 737 MAX, confident the problem isn’t systemic.
Over the last two years, BA’s bottom line has risen 53% on a year over year average with increasing margins. In the Net Income BNRI (adjusted net income) graph below you can see that profits have never been higher. This lean operating company has also significantly grown its free cash flow to over $13 billion at the end of 2018 giving Boeing a considerable amount of financial flexibility for acquisition and internal innovation/growth.
Boeing is currently trading at an 18.10 price to earnings ratio (P/E) which is a very reasonable valuation considering this multiple got as high as 30.63 in January of last year before trade tensions hit the fan (shown on the graph below). With Boeing being the US’ largest exporter its valuation got walloped when the “trade war” with China began. Every day the tensions seem to be diminishing, with a deal looming on the horizon I am confident that a resolution is near. Getting in before this multiple adjusts up to pre-trade war levels could turn out to be a very profitable trade. With lowered multiples and raising EPS, this has placed the continuously profitable company as Zacks Rank #1 (Strong Buy).
Lockheed Martin is Boeings biggest competitor for government aerospace contracts being the largest defense contractor in the world. LMT has a niche portfolio of military aircraft that has won them many government contracts; most notably their F-35 program which is considered their primary growth driver is 20% of total revenue and growing. The F-35 program is incredibly expensive though, and the US government is pressuring them to reduce costs which could negatively affect the bottom line. LMT’s broader portfolio is under intense competition with almost all of their revenue coming from defense contracts. Meanwhile, competitors like Boeing who only have 22% of revenue relying on these contracts have a distinct diversification advantage. These concerns lead me to agree with Zacks Ranks #3 (Hold) for LMT.
Textron is a multi-industry conglomerate that operates five segments: Bell, Textron Systems, Textron Aviation, Industrial and Finance. Over 60% of their revenue comes from their aerial transportation segments (Bell Helicopters and Textron Aviation). They have won a number of contracts this year most notably a $912 million order for 12 AH-1Z Viper attack helicopters to the Royal Bahraini Air Force.
TXT is currently trading 28% below its 52 week high that it reached in September of last year (shown below). This drop is due to the systemic issues stemming from trade tensions as well as the overall market sell-off at the end of 2018. The company shows inconsistent top and bottom line growth because of the competitive nature of the space. There have been a few upwardly adjusted EPS estimates that have pushed the stock into a Zacks Rank #2 (Buy) spot. With trade tension easing, a diverse portfolio, and EPS estimates on the rise, this buy ranking accurately reflects how I view a position in TXT.
Each of these three aerospace and defense stocks have a beta above 1 meaning that they will on average outperform a bull market and underperform a bear market. This high beta is a double-edged sword and should be considered before investing in any of these stocks. When a trade deal is finally made between the US and China, I am confident that these equities should all see a substantial rally because of how much each of these companies relies on exports.
Zacks' Top 10 Stocks for 2019
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