The US aerospace industry is soaring right now. The sector is experiencing annual growth rates of 14% and last year contributed $143 billion in export sales to the US economy.
Fuelling this growth has been increased military spending both at home and abroad, with China, India and Japan all increasing their defence budgets.
But it’s not all clear skies. An ageing workforce and a lack of qualified engineers to fill posts has forced the industry to digitise. Any problems delivering orders is a serious concern to an industry that supports over 700,000 jobs in the US.
Why invest in aerospace stocks?
Over the past 5 years, the S&P Aerospace & Defence Select Industry Index has climbed almost 90%, and 36% since the start of 2017.
New entrants on the market, like Elon Musk’s Space X, have forced established players to up their game. Companies like Boeing [BA]
, Aerojet Rocketdyne [AJRD]
and TransDigm Group [TDG]
have responded by securing lucrative military contracts and making savvy acquisitions, which have delivered growth and rewarded shareholders. Each has managed to top analyst expectations in 2018, yielding higher-than-forecasted earnings and all-time-high share prices.
The question is whether they can now continue these impressive gains into 2019.
| ||Boeing||TransDigm group Inc.||Aerojet Rocketdyne|
|Earnings per share (ttm)||17.03||16.20||0.80|
|Quarterly revenue growth (YoY)||3.8%||13.6%||3%|
|Quarterly Earnings Growth||30.6%||49.1%||415.9%|
Source: Yahoo Finance, 26 November 2018
Boeing: a soaring share price
Industry heavy-weight Boeing has benefitted more than most from President Trump’s $717 billion defence bill. Over the summer the company landed 20 big-ticket military contracts, collectively worth more than $13.7 billion, with the Pentagon getting new drones and even a couple of Air Force Ones for its money.
This has fuelled bumper Q3 revenue of $25.16 billion and an earnings per share of $3.58, beating expectations by about 11 cents. Boeing is now on course to post $100 billion in full-year revenue - a first for the storied company.
While the stock is up almost 10% on the year, most of these gains came in the first two weeks of January. Since then it has been unable to break out of the $320 to $392 range, with the ongoing US-China trade war clipping the share price’s wings. China is a big customer of Boeing, accounting for a third of Boeing 737 orders.
Boeing share price performance, NASDAQ interactive chart, as at 26 November
Then there’s the tragic Indonesian aeroplane disaster where a brand new Boeing 737 Max 8 crashed into the Java Sea, killing all on board. Shares fell over 2% earlier this month as concerns over the plane’s safety features started to surface. Litigation against the aviator has already begun, which could have a longer-term impact on the stock.
Investors will also be wary of Boeing’s level of debt. With a debt to equity ratio of -8.67, debt outstrips net cash. Even with an EBITDA of $12.6 billion, any hiccups securing financing for growth initiatives could cause turbulence in the stock.
Aerojet Rocketdyne: reducing its debt baggage
Missile and rocket maker Aerojet Rocketdyne has taken a different route to Boeing. Under the leadership of president and CEO Eileen Drake the company has responded to the threat of Space X through a long-term Competitive Improvement Program.
Drake has slashed debt in order to ignite the company’s mergers and acquisitions program, with a $231 million savings target by 2021. Already it has nabbed ballistic missile specialist Cole Aerospace for a cool $15 million.
Some decisions have been harder than others. In April last year, the company cut 1,100 jobs and moved rocket engine work out of its historic Sacramento facility.
“Given the dynamic nature of this industry, strategic business decisions such as these, while difficult, are critical to establishing a solid course for our future,” Drake said at the time.
The changes seem to be working. Following October’s robust Q3 results, which saw profits of $34.8 million, the company’s share price skyrocketed 16% to $35.32. GAAP earnings came in at $0.82 per share, a huge increase from the $0.17 seen in the same quarter last year.
Aerojet Rocketdyne share price performance, NASDAQ interactive chart, as at 26 November
Weighing on the company’s future has been a slide in orders. Growth in Q2 was very much driven by increased deliveries on the Standard Missile and PAC-3. But in Q3 the backlog was down from $3.9 billion worth of business to $3.7 billion.
“Given the dynamic nature of this industry, strategic business decisions such as these, while difficult, are critical to establishing a solid course for our future,” - Aerojet Rocketdyne CEO Eileen Drake
With the stock trading away from November’s highs, investors might consider it a bargain if the company continues to reap rewards from its improvements program.
TransDigm Group Inc.: achieving lift-off through acquisitions
TransDigm Group Inc. might not be as well known as Boeing or Aerojet Rocketdyne, but the commercial and military aerospace component manufacturer has been making acquisitions up and down the supply chain.
These acquisitions mean the company can produce and supply highly engineered components for nearly all commercial and military aircraft in use today. Not a bad place to be considering disruptions in getting parts can cause major problems, even for the likes of Boeing.
At the end of September, the share price hit an all-time-high of $372.30, before falling to $312 in October as the global market sell-off took hold. Some of these losses have been recouped, with the share price sitting at $341.11 as at 23 November.
TransDigm Group share price performance, NASDAQ interactive chart, as at 26 November 2018
Like others in the aerospace sector, TransDigm has been beating analyst expectations. Earnings per share in Q4 came in at $4.44 against a consensus forecast of $4.27, generating a Zack’s earnings surprise of 3.98%.
With a P/E ratio of 20.33, the stock could be seen as expensive, however, over the past 12-month period investors have been rewarded with an earnings per share increase of 93%.
Right now, consensus is for next quarter’s earnings per share to come in at $3.68. While this is down from the previous quarter, mid- to long-term growth is expected to be strong, with The Street predicting 14.28% earnings growth next year.
With the industry expected to grow 4.1% in 2018, up from 2.7% the previous year, the trend right now is certainly for growth.
Investors will be looking at how US politics and global trade concerns affect the aerospace industry in 2019. Already the White House has hinted a 5% cut across all government department budgets, which would include the Pentagon. Any cuts to the $700 billion plus defence budget could severely impact the US aerospace industry.
Expected Aerospace industry growth in 2018
Managing debt levels will also be crucial for long-term success. Any hold ups in securing funding could spell trouble for growth initiatives in this highly leveraged industry, as will any barriers to global trade, such as the continuing US-China trade war.
Longer-term, global defence spending is expected to grow by a CAGR of 3% between 2017-2022 to be worth over $2 trillion. Providing the companies can plan for the longer term and ride out any short-term turbulence, share prices could continue to take off.