Jeff Ubben's Aerospace Defense Pick

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Mar 17, 2014

The airplane industry is currently under heavy scrutiny as the Malaysia Airlines flight MH370 remains unfound. Investigators continue to debate over available facts while family members continue to weep over lost relatives. Besides the human loss, question marks began to loom over Boeing 777-ER200’s flight control and navigation system. The 777 is one of the few models by Boeing which Rockwell Collins (COL, Financial) did not supply. However, rumors have that the company has demonstrated interested for supplying the plane’s new version: 777X. The recent event has given the firm a strong window of opportunity to displace Honeywell (HON, Financial). So, is Rockwell Collins fit to take on its rival and push growth forward?

Up-to-date positioning system

Rockwell Collins did not supply the Boeing 777-ER200’s flight control, but it did supply other components. Since mid-2013, the news has been plagued with efforts by the company to supply the updated version (777X) of the model in question with a greater share of components. The opportunity was opened by the US Federal Aviation Administration (FAA) plan to modernize the National Airspace System (NAS) before 2025.The most controversial component is the Aircraft Communications Addressing and Reporting System, or ACARS, developed by Honeywell. ACARS is a Data link Service Provider (DSP) operating terrestrial communication networks, which uplink and downlink ACARS messages to and from aircraft and provide routing to and from terrestrial Command and Control (C2) systems.

The FAA plans to update the system in order to incorporate readily available technology to airplane communications and positioning. Concerning this last point, the Next Generation Air Transportation System, or “NextGen,” is a multi-billion-dollar overhaul that utilizes GPS technology akin to what’s now available in cars and on smartphones. And the company pointed at for supplying the component is Rockwell Collins. Hence, the current uptrend registered on stock performance is expected to continue on the long-term.

Like other selected aerospace and defense programs, NextGen is blessed by high priority. This means that a certain aura will be placed above the program, giving protection against budgetary cuts. That is especially relevant since the installment of The Sequester last year. Hence, the program offers the company a guaranteed growth opportunity.

Mixed feelings and strong performance

To be fair, analysts’ opinions on Rockwell Collins are not homogeneous. While Zacks and Canaccord Genuity’s report maintains a “Neutral” and “Hold” recommendation, EVA Dimensions downgraded the stock to “Underweight.” At the same time, Vice President Jeffrey Standerski sold 2,767 shares of the stock on the open market. Hence, the signals are mixed while overall performance during 2013 improved year-over-year.

Looking ahead, Rockwell Collins’ greatest characteristic is its dual-end products. The company is the foremost global supplier of communications and avionics equipment for both commercial and military customers. A position strengthened by the addition of a high-quality ground network and services, through the acquisition of ARINC Inc. The transaction is a key to offer the FAA a solid proposal and top-of-the-line product.

Besides the USA, Rockwell Collins has placed its eyes on international expansion. For that purpose, the company is increasing its presence in the Middle East, Brazil, China and several European countries. Most importantly, the market introduction of the A350, CSeries, Learjet 85, and Legacy 500, will push growth as these planes that carry a higher percentage of components built by the firm.

Timing and cost

Trading at 17.3 times its trailing earnings, the stock currently carries a 7% discount and started a price rebound. Additionally, debt has been reduced year-over-year while the stock repurchasing program continues underway and operating margins widened for the third year in a row. I applaud Jeff Ubben (Trades, Portfolio)’s decision to increase his share during 2013 and deem this moment as correct for starting a long-term investment.

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