The year 2014 was a dynamic one for the aerospace and defense industry. Rising commercial demand along with a rebounding U.S. economy took most of the sting out of the sequester.
In the race for supremacy in the commercial skies, the North American jet plane maker – Boeing Company (NYSE:BA) − has surpassed its European rival Airbus in 2014 for the third consecutive year as the final delivery numbers are now in for the year. Yet, Boeing shares lost 2.5% in 2014.
Commercial Aerospace Business
The fact remains that this aerospace and defense leader is flying high on the back of rising demand for its new fuel-efficient commercial planes. Boeing once again reported industry record deliveries in 2014, retaining its position as the world’s biggest airplane maker.
The aerospace major reported all-time high jet deliveries for 2014, beating its own projection, driven by strong commercial numbers. The heightened deliveries were also a function of an increased production rate.
Per a report from Boeing, air traffic is expected to grow 5% and cargo traffic to rise 4.7% annually in the next two decades. The majority of this demand surge is expected to come from the Asia-Pacific region on the back of liberalization of regulations in the airline industry in the region and the wide proliferation of low cost carriers across new markets.
The demand picture over the long term is strong enough to accommodate both Boeing and Airbus as well as other smaller players like Bombardier Aerospace, Cessna Aircraft Company and the Brazilian aerospace conglomerate Embraer SA (NYSE:ERJ).
Commercial Hurdles
Even though Boeing nabbed the leading position in terms of deliveries, Airbus came out ahead on orders, signing a net 1,456 contracts versus 1,432 for Boeing. This can be attributed to the glitches Boeing faced with its much-hyped Dreamliner.
Boeing also lost out to its archrival last year on the $14 billion Delta order. Delta Air Lines Inc (NYSE:DAL) placed firm orders for 50 dual-aisle wide-body jets comprising 25 A350-900s and 25 A330-900neos to Airbus.
Boeing’s 787 aircraft continued to face technical disruptions last year despite more than a decade of working out problems. The high-tech, fuel-efficient airplane was supposed to be a game changer in the aviation industry — and it still possibly will be — but it keeps making headlines for the wrong reasons.
After years of delays, Boeing delivered its 787 at a rate of nearly 12 per month in the fourth quarter of 2014, up from about 9 a month for the rest of 2014.
But everything comes at a cost. Investors’ concern about Boeing’s progress in cutting the cost of building its new 787 Dreamliner jets led to a plunge in the company’s share price, even though Boeing reported an otherwise strong, third-quarter 2014 results. The decline came after the company disclosed that the deferred production cost for the 787 program rose 3.9% in the third quarter to approximately $25.2 billion, which could climb even more.
Boeing’s share loss could also be traced to the defeat of the U.S. House Majority Leader Eric Cantor of Virginia in a primary election in the middle of last year. The defeat came as a blow to the company as the market comprehended a threat to the congressional reauthorization of the Export-Import Bank of the U.S. (Ex-Im Bank), the official export credit agency of the country. The agency’s loans had supported billions of dollars worth Boeing aircraft sales in 2013.
Defense Business
The sequestration is still holding off the defense sector, with President Obama signing the $1.1 trillion spending bill into law to fund most of the government through the end of Sep 2015. The bill gives Pentagon $554 billion for fiscal 2015. This compares unfavorably with $572 billion enacted in fiscal 2014. Boeing’s defense revenues declined 4.3% year over year in the nine months period ending Sep 30, 2014.
That said, Boeing’s military aircraft and helicopter deliveries in 2014 were up to 184 from 171 in 2013 and 154 in 2012. The numbers were dominated by deliveries of 54 new-build CH-47 Chinooks and 45 new-build AH-64 Apaches, both of which were up significantly.
The Republican wins in the mid-term election, Middle East tensions, the Obama administration’s major realignment along with the rising U.S. economy may turn out to be a catalyst for this sector. Moreover, under the new military budget, Boeing will secure $1.46 billion for 15 EA-18G Growler attack jets.
Stocks that Outperformed Boeing
More or less all aerospace and defense majors were affected by the budget austerity, but sequestration and cancellation of big ticket items did not do as much damage as was earlier apprehended. Though fourth quarter results have not been announced yet, we have handpicked three stocks that turned out to be better performers than Boeing in terms of the Zacks Rank, earnings surprises, and share price returns.
General Dynamics Corp
Headquartered in Falls Church, VA, General Dynamics offers a broad portfolio of products and services in business aviation; combat vehicles, weapons systems and munitions; shipbuilding; and communication and information technology systems and solutions.
The company’s shares gained 47.3% in 2014 – the highest among the pure-play defense majors. The company currently carries a Zacks Rank #2 (Buy) and has a solid earnings surprise trajectory beating the Zacks Consensus Estimate by an average 7% in the trailing seven quarters.
Its forward price-to-earnings (P/E) multiple stands at 16.61, a 4% discount to the peer group average.
Northrop Grumman Corp. (NOC - Analyst Report)
The company has a strong presence in the Air Force as well as Space & Cyber Security programs. Revenue and earnings growth continue to be driven by its wide presence in the current focus areas of cyber security, modernization of defense and homeland security assets, intelligence, surveillance and reconnaissance (“ISR”) systems, advanced electronics and software development.
This $30.70-billion-market-cap-defense Zacks Ranked #2 company posted an average earnings surprise of 7.5% in six out of the last seven quarters. Northrop Grumman clocked an impressive share price return of 31.4% last year. Its forward P/E is 15.81x, a 3.1% discount to the peer group average.
Huntington Ingalls Industries Inc (NYSE:HII).
The largest military shipbuilder in the U.S., Huntington Ingalls is the prime industrial employer in Virginia. Huntington Ingalls, originally an affiliate of Northrop Grumman, was spun off in Mar 2011. It operates major shipyards in Louisiana, Mississippi and Virginia. The company has an expected earnings growth rate of 24.77%. The company’s forward P/E of 13.95x is at a 19.4% discount to the S&P 500 peer group average. Its share price has gained 26.1% last year.
Despite the budget austerity, we believe Huntington Ingalls will remain well-positioned backed by its effective execution skills and diverse product offerings. The company has delivered positive earnings surprises in five of the last seven quarters, with an average beat of 16.8%.
This Zacks Ranked #2 company is after all more protected than other defense contractors from budget cuts as the U.S. defense department is expanding its fleet of submarines and destroyers and introducing a new version of aircraft carriers, with emphasis on the Asian-Pacific region.
Apart from its strong operational performance, the company also made investor friendly moves, thereby attracting investors. Recently, the company doubled its quarterly cash dividend to 40 cents a share. Additionally, the company’s board of directors boosted its share repurchase program from $300 million to $600 million and extended the program’s deadline from Oct 31, 2017 to Oct 31, 2019.