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The Right Time to Take a Position in Aerospace and Defense

March 07, 2014 | About:

Airplane constructors and defense contractors seem to have left behind the last economic crisis of 2007. Ever since, activity in both industries has picked up and overall performance notably improved after 2010. Two companies were able to fair the bad weather and come out of the storm in a better market positioning. However, Boeing (BA) and Lockheed Martin (LMT) continue to face new challenges that question their capacity to deliver strong returns in the long term.

Addressing Growth Catalysts

The decision to end pensions for non-union workers has placed Boeing under the magnifying glass. Through this approach the company plans to curb growing pension costs by 2016. However, the firm has made clear that employees will continue to receive matching benefits. 68,000 employees are expected to be reached by the new policy, and associated costs are estimated to sum up to $110 million.

Pensions programs for Boeing have shown in 2013 to be a key in growth prospects. Through fiscal 2013, the company reported a growth in total sales for both commercial and defense segments. However, higher pension expenditures continue to erode operating margins. Nonetheless, EPS continue to improve steadily, securing shareholders a considerable return on their investment.

Another good note for Boeing is the rise on orders and backlog for 2014. That reality gave management enough incentives to improve production and increase delivery rates. Order increments are most important in the commercial segment, because sales in the defense sector are expected to drop by $30 billion. However, competition in the sector has relaxed as contracts continue to concentrate in a few market players.

Financially, since 2010 Boeing improved all around. Revenues, net income, and cash flow have risen, with the additional benefit of debt reduction. No transactions have been reported during 2014, and those reported during fourth quarter 2013 were sales. However, those sales represent the will of gurus to collect wins. Trading at 21.6 times its trailing earnings, the stock carries an 11% premium to the industry average.

Successful Portfolio and Good Prospects

Lockheed Martin is only half the market cap of Boeing. Nonetheless, the Maryland base if a strong competitor in the aerospace, defense, and security industry. In comparison to Boeing, the firm has no commercial segment and heavily depends on the U.S. defense budget. However, its business was not as affected as other market competitors due to the priority given by the Department of Defense to the contracts awarded before the 2007 economic crisis.

The most successful product by Lockheed Martin is the F-16 with 4,534 units delivered worldwide. Another important product in its portfolio is the Hercules C-130, which is expected to lose some footing in the hands of EMBRAER’s project: KC-390. The company, however, has not slept in its laurels and continues to develop new products. The F-35 is the most important product waiting to be launched, but rising production costs continue to threat the project.

The Department of Defense is also a big consumer of fire control, missiles, and mission systems developed by Lockheed Martin. Additionally, the Littoral Combat ship, jointly developed by the U.S. and Japan, has incremented backlog and offers the company good prospects for the long term. And during the last U.S. administration, the greater focus on unmanned intelligence surveillance reconnaissance systems, gives the firm an opportunity for growth.

Not much has changed in the financial side for Lockheed Martin since 2009. Revenues, net income, and operating margins stood at similar levels throughout that period. However, gurus have cut their winning through 2013’s last quarter. Nonetheless, no major stakeholder liquated its position. Trading at 18.5 times its trailing earnings, the stock carries a 4% discount to the industry average.

Defense over Commercial Planes

Without a doubt Boeing’s strong market is commercial airplanes, while Lockheed Martin’s is defense. Both markets are recovering and offering opportunities for growth to both firms. Additionally, the premium carried by Boeing’s stock in small making the two stocks attractive for a long-term investment. However, Lockheed Martin has benefited more than Boeing from the reduction of competitors, and is my favorite pick.

Disclosure: Vanina Egea holds no position in any of the mentioned stocks.

About the author:

Vanina Egea
A fundamental analyst at Lone Tree Analytics

Visit Vanina Egea's Website


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