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4 Aerospace-Defense Stocks to Watch as Low Air Traffic Concerns Loom

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Aparajita Dutta
·9-min read
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The emergence of COVID-19 virus variants and the resultant increase in the number of cases have once again created a downside risk for airlines companies, thereby casting a shadow on commercial jet makers’ future. Whatever recovery was earlier anticipated has slowed down lately due to these new challenges, thereby worsening the outlook for air passenger volumes.

Moreover, import tariff imposition on steel and aluminum remains a threat for manufacturing stocks in the aerospace-defense space. Nevertheless, manufacturers, which have a balanced portfolio with ample military products for sale, might be in a safe corner for the time being. The frontrunners in the aerospace-defense industry are Lockheed Martin (LMT), Northrop Grumman (NOC), L3Harris Technologies (LHX) and Leidos Holdings (LDOS).

About the Industry

The Zacks Aerospace-Defense industry comprises companies that primarily design and manufacture heavy-built products like commercial as well as military jets and helicopters, tankers and other combat vehicles, missiles, combatant ships as well as auxiliary ships, submarines, bombs, guns, space transportation vehicles, military satellites and a few more.

The industry also includes cyber security players who offer information technology (IT) services and C4ISR (command, control, communications, computers, intelligence, surveillance and reconnaissance) solutions.

A portion of revenues comes from defense contractors, offering spare parts, aircraft modification, ship repair and overhaul services and supply chain management services.

3 Trends Shaping the Future of the Aerospace-Defense Industry

Poor Air Traffic Outlook Continues to Hurt Prospects: Global air traffic has been low since last March, when the outbreak of coronavirus forced governments across the world to impose stringent travel restrictions. Per a report published by the International Air Transport Association (IATA), air passenger traffic measured by revenue passenger-kilometers plunged 66% in 2020, which was the biggest shock that the aviation industry has experienced. Low passenger volumes have been hurting prominent jet makers like Airbus and Boeing (BA) since airlines have drastically lowered aircraft orders and, in some cases, cancelled them altogether. Although a slow recovery was observed in December, as some governments lifted travel restriction and vaccine developments fueled hopes for the industry’s recuperation, the emergence of virus variants and the consequent rise in the number of cases have once again created a downside risk for the industry. IATA projects that airlines are likely to burn a total of $75 billion worth cash in 2021, which might be as high as $95 billion, in case of slower market opening. Such a cash crunch will not allow airlines to invest in new jets, thereby hurting near-term growth prospects of jet manufacturers and associated companies.

Military Business Offers a Breather: While the COVID-19 impact has been a traumatic one for the commercial aerospace market, the defense side of the industry has been offering some support, cushioned by steady government support. An expansionary budgetary amendment adopted by the former U.S. government for defense has acted as a major catalyst for this. Notably, under Donald Trump, defense spending increased nearly 15%, as stated by a Bloomberg article. With the United States being the largest supplier of defense products, the nation’s aerospace and defense stocks continued to witness a smooth flow of orders from Pentagon and other U.S. allies even amid the pandemic. This indicates modest revenue generation for industry players like General Dynamics (GD), Textron (TXT) and Huntington Ingalls (HII), which are more focused on the defense business, for the coming days.

Import Tariff Imposition May Continue to Hurt
: In January 2020, the Trump administration announced plans to expand its existing tariffs on imports of steel and aluminum. From Feb 8, steel and aluminum derivatives also came under the tariff mandate. This new import tariffs were in addition to 10% import tariffs imposed on aluminum and 25% import tariffs imposed on steel from most countries in 2018. Now the latest tariff expansion is expected to have dealt a heavy blow to the U.S. aerospace and defense industry, which relies heavily on imported aluminum. This is because such tariffs are bound to push up overall manufacturing cost of the industry, thereby increasing cost of the airplanes. Although trade negotiations are going on between the United States and Britain, there is no surety that the tariffs will be lifted any time soon.

Zacks Industry Rank Indicates Dismal Prospects

The Zacks Aerospace-Defense industry is housed within the broader Zacks Aerospace sector. It currently carries a Zacks Industry Rank #222, which places it in the bottom 13% 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 2.4% to $8.11 since November 2020.

Before we present a few aerospace-defense 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, Tops Sector

The Aerospace-Defense industry has underperformed the Zacks S&P 500 composite but outperformed its own sector over the past year. The stocks in this industry have collectively lost 10.1%, while the Aerospace sector has plunged 15.7%. The Zacks S&P 500 composite has however risen 30.5% in the said timeframe.

One-Year Price Performance

Industry’s Current Valuation

On the basis of trailing 12-month EV/Sales ratio, which is used for valuing capital intensive stocks like aerospace-defense, the industry is currently trading at 2.05, compared with the S&P 500’s 4.60 and the sector’s 2.79.

Over the past five years, the industry has traded as high as 2.05X, as low as 1.05X, and at the median of 1.60X, as the charts show below.

EV-Sales Ratio TTM

4 Aerospace-Defense Stocks to Keep a Close Eye on

Lockheed Martin: Based in Bethesda, MD, Lockheed is the largest defense contractor in the world. Its product line includes renowned fighter jets like F-35, F-16, C-130J along with combat proven missiles like Terminal High Altitude Area Defense System (THAAD) and PAC-3 Missiles. It is also the manufacturer of the Aegis Combat System, which is referred to as the world’s most advanced combat system. The company is set to complete its Aerojet Rocketdyne’s acquisition this year, which will enable it to expand its footprint in the rocket engine market, apart from boosting its hypersonic technology related product line.

The Zacks Consensus Estimate for Lockheed’s 2021 earnings has moved up 0.3% in the past 60 days and indicates year-over-year increase of 7.4%. The company delivered an average earnings surprise of 3.97% in the last four quarters. The company currently holds a Zacks Rank #3 (Hold).

Northrop Grumman: Based in Falls Church, VA, Northrop Grumman is one of the top largest U.S. defense contractors in terms of revenues. Its product line is well positioned in high-priority categories, such as defense electronics, unmanned aircraft and missile defense. The company’s recent divestment of its federal IT and mission support services business to Peraton for $3.4 billion in cash will enable it to boost its share repurchase and debt retirement programs.

The Zacks Consensus Estimate for Northrop Grumman’s first-quarter 2021 earnings indicates year-over-year increase of 6.8%. The company delivered an average earnings surprise of 6.99% in the last four quarters. The company currently holds a Zacks Rank #3. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

L3Harris Technologies: Based in Melbourne, FL, L3Harris is a technology-oriented aerospace and defense player. In January 2021, the company won a multi-year contract involving the Missile Defense Agency’s hypersonic and ballistic tracking space sensor program (HBTSS). Through this deal, the company will develop a prototype satellite that will demonstrate L3Harris’ capability to detect and track hypersonic weapons in space. These competitive wins have a potential value of over $5 billion and will enable L3Harris to play a lead role with multiple agencies and mark the culmination of a successful multi-year repositioning strategy.

The Zacks Consensus Estimate for L3Harris’ 2021 earnings has moved up 0.7% in the past 30 days and indicates year-over-year increase of 11.4%. The company delivered an average earnings surprise of 5.5% in the last four quarters. The company currently has a Zacks Rank #3.

Leidos Holdings: Based in Reston, VA, Leidos Holdings is a global science and technology leader that serves the defense, intelligence, civil and health markets. In January 2021, Leidos Holdings completed acquisition of 1901 Group for $214 million, which is set to expand Leidos Holdings’ share in the addressable cloud and digital modernization service mark. On Feb 22, 2021, the company signed a purchase agreement worth $380 million for Gibbs & Cox that will extend its existing Maritime business and add specific capabilities and services, such as naval architecture and marine engineering, 3D modelling and design. Such notable acquisitions will further add impetus to Leidos Holdings’ top line performance in the coming days.

The Zacks Consensus Estimate for Leidos Holdings’ 2021 earnings indicates year-over-year increase of 8.9%. The company delivered an average earnings surprise of 15.08% in the last four quarters. The company currently holds a Zacks Rank #3.

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