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Coronavirus Mars Aerospace-Defense Stocks' Near-Term Prospects

Aparajita Dutta

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.  Some of the prominent stocks in this industry are Huntington Ingalls Industries (HII), General Dynamics (GD) and Textron.

Here are the three major industry themes:

  • The rapid spread of coronavirus outside China around middle of March 2020 forced governments to implement stringent travel restrictions and as a result global air traffic was hit badly. Per a report by the International Air Transport Association (IATA), as of early April, the number of flights globally was down 80% from 2019. This hurt prominent jet makers like Airbus and Boeing (BA) since airlines drastically lowered aircraft orders and in some cases canceled them altogether. This has affected the order growth trend for premier jet makers in the recent months and in turn forced a handful of them to cut down or even halt production in some parts of their operation. While the production halt is likely to weigh on future revenues, the plane makers are expected to incur expenses associated with the storage of the finished products that are ready for delivery. Moreover, reduced flights indicate lower revenues from the services that the aerospace-defense stocks offer to airlines. Since the majority of the nations are still struggling with the pandemic’s impact, aerospace-defense stocks’ woes are unlikely to subside in the near term.
     
  • While the coronavirus outbreak dealt a big blow to the commercial aerospace market, the defense side of the industry remains relatively cushioned by steady government support. An expansionary budgetary amendment adopted by the U.S. government for defense further reflects this. Notably, President Donald Trump allocated generously to 2020 defense budget, ramping up Pentagon's spending power by 30% from 2019 to $738 billion.  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 who are more focused on defense business in the coming days.
     
  • In January 2020, the Trump administration announced plans to expand its existing tariffs on imports of steel and aluminum, stating that from Feb 8, steel and aluminum derivatives will also come under the tariff mandate. Now this tariff expansion is expected to deal a heavy blow to the U.S. aerospace and defense industry, which relies heavily on imported aluminum.  In 2018, when the initial tariff was imposed, the AIA had expressed concern by saying that such a tariff will raise cost and disrupt the supply chain. Now that tariffs are being imposed on derivatives as well, the growth prospects for defense stocks seem bleak.

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 #151, which places it in the bottom 40% 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 estimates for the current fiscal year have gone down 33.8% to $6.19 since February 2020.

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, 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 21.7%, while the Aerospace sector has plunged 22.6%. The Zacks S&P 500 composite has however risen 7.2% 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 1.58, compared with the S&P 500’s 2.97 and the sector’s 1.57.

Over the past five years, the industry has traded as high as 1.97X, as low as 1.07X, and at the median of 1.76X, as the charts show below.

Bottom Line

Like a silver lining in the cloud, a gradual rise in air travel has been observed in the United States since mid-May. This brought some relief to companies that serve the commercial aftermarket. However, considering the fact that only domestic flights are allowed and that too at a reduced capacity, the aerospace-defense industry’s recovery still seems far off.  

Nevertheless, we must keep in mind fact that the aerospace and defense industry still remains one of the biggest manufacturing sectors in the United States, and will rebound once the impact of the outbreak wears down. Considering this, investors may want to hold a few dominant stocks in this space that have a strong earnings outlook.

We are presenting four aerospace-defense stocks with a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Lockheed Martin (LMT): For this Bethesda, MD-based company, the Zacks Consensus Estimate for 2020 EPS indicates year-over-year improvement of 9.6%. This stock came up with average positive earnings surprise of 7.40% in the trailing four quarters.

Northrop Grumman (NOC): For this Falls Church, VA-based company, the Zacks Consensus Estimate for 2020 EPS indicates year-over-year improvement of 4.3%. This stock came up with average positive earnings surprise of 9.31% in the trailing four quarters.

L3Harris Technologies (LHX): For this Melbourne, FL-based company, the Zacks Consensus Estimate for 2020 EPS indicates year-over-year improvement of 12.2%. This stock came up with average positive earnings surprise of 6.24% in the trailing four quarters.

Leidos Holdings (LDOS): For this Reston, VA-based company, the Zacks Consensus Estimate for 2020 EPS indicates year-over-year improvement of 0.6%. This stock came up with average positive earnings surprise of 6.65% in the trailing four quarters.

 

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Northrop Grumman Corporation (NOC) : Free Stock Analysis Report
 
Lockheed Martin Corporation (LMT) : Free Stock Analysis Report
 
L3Harris Technologies Inc (LHX) : Free Stock Analysis Report
 
Leidos Holdings, Inc. (LDOS) : Free Stock Analysis Report
 
Huntington Ingalls Industries, Inc. (HII) : Free Stock Analysis Report
 
General Dynamics Corporation (GD) : Free Stock Analysis Report
 
The Boeing Company (BA) : Free Stock Analysis Report
 
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