Increasing travel volume, as is evident from increased revenue passenger-kilometers (RPKs) observed in November 2022, is boosting the growth prospects of aerospace-defense equipment stocks. However, COVID-led supply chain disruption might hurt the earnings and cash flows of the industry. Also, a stronger U.S. dollar puts pressure on airlines, which, in turn, may hurt aerospace-defense equipment stocks, particularly those engaged in commercial aerospace. Nevertheless, frequent mergers and acquisitions tend to boost the revenue generation prospects of the industry players. 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 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 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 small and medium-sized mergers and acquisitions (M&As) besides the big mergers witnessed in the industry. In October 2022, Heico Corp.’s 3D PLUS subsidiary acquired TRAD SAS, which is a leader in highly specialized field of radiation engineering. Notably, TRAD’s services and products are used primarily in the space, nuclear and medical fields. Thus, its acquisition will strengthen Heico’s position in the aeronautic, defense, space and medical markets. 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, which dwindled at the onset of 2022, thanks to the sporadic outbreak of the Omicron variant, has regained its growth trajectory in the past few months. Per the latest report published by the International Air Transport Association (IATA), revenue passenger-kilometers (RPKs) increased 41.3% year over year in November 2022, continuing the recent trend. As stated by U.S. Travel Association, domestic business travel volume is expected to reach 96% of pre-pandemic levels in 2023. This makes us optimistic about the near-term growth prospects of aerospace-defense equipment industry stocks, especially those engaged in commercial aviation.
Unusual Strength of the Dollar Remains a Concern: The accelerated appreciation of the U.S. dollar in 2022 was led by the Russia-Ukraine war. This war, in turn, has been a major catalyst behind the latest inflation surge. 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. Thus, an appreciated U.S. dollar value remains a risk for aerospace-defense equipment stocks, particularly the ones in commercial aerospace.
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 result in 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 #92, which places it in the top 37% 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.
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 and its sector over the past year. The stocks in this industry have collectively gained 2.3%, while the Aerospace sector has declined 3.1%. The Zacks S&P 500 composite has dropped 18.8% 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 2.50X compared with the S&P 500’s 3.19X and the sector’s 2.26X.
Over the past five years, the industry has traded as high as 2.69X, as low as 2.16X, and at the median of 2.45X, 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 November 2022, the company announced its fourth-quarter fiscal 2022 results. Its fiscal fourth-quarter net sales improved 13% year over year, while earnings per share from continuing operations rose 11%.
The Zacks Consensus Estimate for TransDigm’s fiscal 2023 earnings indicates a 26.4% improvement from fiscal 2022’s estimated figure. The stock has a four-quarter average earnings surprise of 5.22%. The company currently sports a Zacks Rank #1 (Strong 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, which delivers a full range of products and services for air, land and naval forces, as well as advanced electronics, security, information technology solutions and customer support services. In January 2023, Bae Systems announced that it has completed the purchase of a number of properties within the Barrow-in-Furness town center to support its future growth plans.
The Zacks Consensus Estimate for BAESY’s fiscal 2023 sales implies an improvement of 22% from the fiscal 2022 estimated figure. Its fiscal 2023 earnings estimate indicates a 30% improvement from the fiscal 2022 estimated figure. The company currently holds a Zacks Rank #1.
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 as well as advanced surface treatment technologies. In November 2022, the company declared that it had completed the acquisition of the stock of Keronite Group Limited (Keronite) for $35 million in cash. Notably, Keronite is a leading provider of Plasma Electrolytic Oxidation surface treatment applications offering corrosion protection, wear resistance, thermal protection and electrical insulation for the defense, commercial aerospace and industrial vehicle markets, and also in semiconductor manufacturing.
The Zacks Consensus Estimate for CW’s 2022 earnings suggests an annual improvement of 10.6%. The stock has a four-quarter average earnings surprise of 5.67%. The company currently has a Zacks Rank #2 (Buy).
Price & Consensus: CW
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