Chicago, IL – April 5, 2023 – Today, Zacks Equity Research discusses Raytheon Technologies RTX, TransDigm Group TDG and Curtiss-Wright CW.
Industry: Defense Equipment
Link: https://www.zacks.com/commentary/2074130/3-defense-equipment-stocks-to-buy-amid-impressive-air-traffic-view
Impressive air travel volume outlook, measured by revenue passenger kilometers, is boosting the prospects of aerospace-defense equipment stocks. However, COVID-led supply chain disruption might hurt the earnings and cash flows of the industry. Also, rising fuel prices might lead to airlines reducing their order for new aircraft from jet manufacturers, which, in turn, may hurt aerospace-defense equipment stocks, particularly those engaged in commercial aerospace.
Nevertheless, notable 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 Raytheon Technologies, TransDigm Group and Curtiss-Wright.
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.
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 March 2023, AAR Corp. completed the acquisition of the aircraft maintenance, repair and operation (MRO) and fleet management software provider, Trax USA Corp, for $120 million plus up to a $20-million earn-out payment.
The acquisition will assist AAR Corp. in scaling up its aftermarket service operations and broadening its product portfolio, thus accelerating its revenue generation prospects. Consolidations such as this should improve economies of scale for the industry as a whole, with the players gaining access to diversified business models.
Impressive Air Traffic View Boosts Prospects: World air travel data has been improving. Per a report published by the International Air Transport Association (IATA), in January 2023, global revenue passenger-kilometers (RPKs) increased 67% year over year and were 84.2% of January 2019 levels. Impressively, the U.S. domestic market continued its robust recovery, with domestic RPKs climbing 26.8% year over year and up 3.1% above levels achieved in January 2019.
The IATA stated in its latest economic outlook that based on the current recovery momentum, it expects total global RPKs to increase by around 20% in 2023. This makes us optimistic about the near-term growth prospects of aerospace-defense equipment industry stocks, especially those engaged in commercial aviation.
Rising Fuel Price May Hurt: Fuel remains one of the main operational cost items for an airline, typically accounting for 20-25% of the industry’s total expenses, as stated by IATA in its latest global outlook. Notably the Russia-Ukraine conflict prompted a sharp rise in world oil price, which returned to above $100/bbl for the first time since 2014. IATA expects oil prices to moderate somewhat over the forecast horizon, easing to around $92 in 2023 from around $102 in 2022.
However, such an expected moderate price decline might not be sufficient to boost airlines’ profit. The ongoing recovery in air traffic volumes is projected to push up the airline industry’s fuel bill to around $229 billion in 2023. This might lead to airlines reducing their orders for new aircraft from jet manufacturers like Boeing and Airbus, which, in turn, might result in a decline in demand for products from aerospace equipment manufacturers like TransDigm and Triumph Group.
Supply Chain Disruption Poses Risk: The COVID-19 pandemic has led to an unprecedented crisis in the aerospace and defense supply chain. Notably, Original Equipment Manufacturers (OEMs) needed to dramatically scale back their capacity to reflect the new realities of the commercial air travel market. Such OEM rate reductions are still affecting the extended commercial aerospace manufacturing supply chain, to some extent, which might result in lower earnings and cash flows for the industry in the near term.
The Zacks Aerospace-Defense Equipment industry is housed within the broaderZacks Aerospace sector. It currently carries a Zacks Industry Rank #59, which places it in the top 24% 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.
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 lost 4.9%, while the Aerospace sector has declined 6.5%. The Zacks S&P 500 composite has dropped 10.2% in the same timeframe.
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 2.34X compared with the S&P 500’s 3.39X and the sector’s 2.16X.
Over the past five years, the industry has traded as high as 2.69X, as low as 2.15X, and at the median of 2.39X.
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 March 2023, Curtiss-Wright won a follow-on contract from the United States Marine Corps to provide small form factor network router and switch modules to support communications modernization with highly portable expeditionary network communications technology. Per the contract, Curtiss-Wright will provide a Modular Open Systems Approach deployed baseband system for the Marine Corps Wideband Satellite-Expeditionary program. This should solidify CW’s position in the Defense Electronics market.
The Zacks Consensus Estimate for CW’s 2023 earnings suggests an annual improvement of 4.9%. The stock has a four-quarter average earnings surprise of 4.42%. The company currently has a Zacks Rank #2 (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 March 2023, TransDigm revealed that it has signed an agreement to purchase Calspan Corporation. This acquisition should strengthen TransDigm’s expertise in providing aftermarket-focused development services for both the commercial and defense aerospace end markets.
The Zacks Consensus Estimate for TransDigm’s fiscal 2023 earnings indicates a 30.3% improvement from the fiscal 2022 reported figure. The stock has a four-quarter average earnings surprise of 7.60%. The company currently has a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Raytheon Technologies: Based in Waltham, MA, Raytheon Technologies is an aerospace and defense company providing advanced systems and services for commercial, military and government customers worldwide. In April 2023, the company won a contract worth $1.2 billion for providing Switzerland with the Patriot air defense system. This reflects the solid demand that RTX enjoys in the defense market.
The Zacks Consensus Estimate for RTX’s 2023 sales implies an improvement of 7.8% from the 2022 reported figure. Earnings estimates for 2023 indicate a 5.2% improvement from the 2022 reported figure. The company currently holds a Zacks Rank #2.
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