At the peak of one cycle and the trough of another
We are at the peak of a decade long boom in Defense spending, and at the trough of a two year Aerospace bear market. Goldman Sachs is upgrading Aerospace to Attractive and downgrading Defense to Cautious, and expect A&D investors to increasingly rotate out of the latter and into the former, particularly given that, at current trading levels, one pays the same price for trough Aerospace earnings as they do for peak Defense earnings.
Firm is upgrading Aerospace to Attractive given:
1) Traditional Buy signals are turning green. The second derivative in yoy air traffic and the level of aircraft orders are both close to a bottom, which typically indicates the start of an upturn in the group.
2) Expectations are low and sentiment is weak, as evidenced by the significant decline in consensus estimates as well as positive stock reactions to downward guidance revisions when companies report.
3) Attractive valuation + positive catalysts. In prior cycles, Aerospace stocks consistently decline 50% peak to trough, which is where the group is today. Multiples have bounced off lows, but still near trough, and have potential to double. Several near-term positive catalysts could drive multiple expansion (BA conference, Paris Air Show, 787 first-flight).
Goldman is upgrading Boeing to Neutral from Sell, Spirit to Buy from CL Sell, and Rockwell Collins to Buy from Neutral. Goodrich remains CL Buy rated. They also revise their estimates and price targets across the group.
Firm is downgrading Defense to Cautious given:
1) Defense spending has peaked, and history suggests an extended downturn is possible as Defense spending typically moves in decade long cycles. Defense stocks underperform when spending is declining.
2) Defense is lower priority than it used to be. It has become very clear in recent months that Defense is atthe lower end of the new Administration’s list of priorities, and could increasingly become a bill payer for other government spending.
3) The stocks are not as inexpensive as they appear, and our analysis shows that the group could see relative multiple compression, coupled with earnings declines beyond the end of the decade.
They are downgrading Northrop Grumman to Sell and adding it to the Conviction Sell List, and downgrading L-3 and Raytheon to Neutral from Buy. They also make modest downward revision to PT and estimates.
Notablecalls: Plenty to choose from:
- Aerospace: Spoke to one contact who thinks Boeing (NYSE:BA) will see some buying interest on the upgrade as Goldman has done a good job covering the stock. They stayed on Sell for a long time and have started gradually moving towards a more positive view over the past months, removing the Conviction Sell and now upgrading to Neutral.
They are also adding SPR to their Buy list from Conv. Sell and raising tgt to $17 from $12.
- Defense: I like the Northrop-Grumman (NYSE:NOC) downgrade to Conviction Sell with a $40 tgt. The squeeze is over.
Additionally we have JP Morgan out with some cautious comments on the Defense sector saying the recent rally is starting to look long in the tooth.
After underperforming the S&P 500 by 21% from the end of January through mid March, the four largest defense primes have now outperformed by 19% over the past two months. The budget release, solid earnings, low valuations, and short covering have all driven the recent rally. However, they have difficulty seeing continued material outperformance due to a weak fundamental outlook and an
absence of positive catalysts.
Valuations reached depressed levels by mid March, with the four primes trading at an average multiple of only 6.5x our 2010 earnings estimates. As they commented at the time, the stocks were ripe for a rally given where they were trading, the potential for the budget release to eliminate much of the uncertainty that was making investors flee from them, and the likelihood that Q1 earnings and guidance for 09 would be solid. Now that a rally has taken place, they see tougher outlook for relative performance.
Several incremental data points have been negative. Beyond the well telegraphed budget cuts announced last month by Secretary Gates, they have seen a number of other data points recently that reinforce their belief that the administration has many other priorities that come before defense, intelligence, and space contracting.
We are at the peak of a decade long boom in Defense spending, and at the trough of a two year Aerospace bear market. Goldman Sachs is upgrading Aerospace to Attractive and downgrading Defense to Cautious, and expect A&D investors to increasingly rotate out of the latter and into the former, particularly given that, at current trading levels, one pays the same price for trough Aerospace earnings as they do for peak Defense earnings.
Firm is upgrading Aerospace to Attractive given:
1) Traditional Buy signals are turning green. The second derivative in yoy air traffic and the level of aircraft orders are both close to a bottom, which typically indicates the start of an upturn in the group.
2) Expectations are low and sentiment is weak, as evidenced by the significant decline in consensus estimates as well as positive stock reactions to downward guidance revisions when companies report.
3) Attractive valuation + positive catalysts. In prior cycles, Aerospace stocks consistently decline 50% peak to trough, which is where the group is today. Multiples have bounced off lows, but still near trough, and have potential to double. Several near-term positive catalysts could drive multiple expansion (BA conference, Paris Air Show, 787 first-flight).
Goldman is upgrading Boeing to Neutral from Sell, Spirit to Buy from CL Sell, and Rockwell Collins to Buy from Neutral. Goodrich remains CL Buy rated. They also revise their estimates and price targets across the group.
Firm is downgrading Defense to Cautious given:
1) Defense spending has peaked, and history suggests an extended downturn is possible as Defense spending typically moves in decade long cycles. Defense stocks underperform when spending is declining.
2) Defense is lower priority than it used to be. It has become very clear in recent months that Defense is atthe lower end of the new Administration’s list of priorities, and could increasingly become a bill payer for other government spending.
3) The stocks are not as inexpensive as they appear, and our analysis shows that the group could see relative multiple compression, coupled with earnings declines beyond the end of the decade.
They are downgrading Northrop Grumman to Sell and adding it to the Conviction Sell List, and downgrading L-3 and Raytheon to Neutral from Buy. They also make modest downward revision to PT and estimates.
Notablecalls: Plenty to choose from:
- Aerospace: Spoke to one contact who thinks Boeing (NYSE:BA) will see some buying interest on the upgrade as Goldman has done a good job covering the stock. They stayed on Sell for a long time and have started gradually moving towards a more positive view over the past months, removing the Conviction Sell and now upgrading to Neutral.
They are also adding SPR to their Buy list from Conv. Sell and raising tgt to $17 from $12.
- Defense: I like the Northrop-Grumman (NYSE:NOC) downgrade to Conviction Sell with a $40 tgt. The squeeze is over.
Additionally we have JP Morgan out with some cautious comments on the Defense sector saying the recent rally is starting to look long in the tooth.
After underperforming the S&P 500 by 21% from the end of January through mid March, the four largest defense primes have now outperformed by 19% over the past two months. The budget release, solid earnings, low valuations, and short covering have all driven the recent rally. However, they have difficulty seeing continued material outperformance due to a weak fundamental outlook and an
absence of positive catalysts.
Valuations reached depressed levels by mid March, with the four primes trading at an average multiple of only 6.5x our 2010 earnings estimates. As they commented at the time, the stocks were ripe for a rally given where they were trading, the potential for the budget release to eliminate much of the uncertainty that was making investors flee from them, and the likelihood that Q1 earnings and guidance for 09 would be solid. Now that a rally has taken place, they see tougher outlook for relative performance.
Several incremental data points have been negative. Beyond the well telegraphed budget cuts announced last month by Secretary Gates, they have seen a number of other data points recently that reinforce their belief that the administration has many other priorities that come before defense, intelligence, and space contracting.
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