Zacks Industry Outlook Highlights: Lockheed Martin, Raytheon, United Technologies, Rockwell Collins and Northrop Grumman
Zacks Equity Research
Updated
For Immediate Release
Chicago, IL – December 14, 2015 – Today, Zacks Equity Research discusses the Aerospace/Defense (Part 2), including Lockheed Martin (LMT), Raytheon Company (RTN), United Technologies (UTX), Rockwell Collins Inc. (COL) and Northrop Grumman ( NOC).
No country in the world can match the U.S. when it comes to military spending. In 2014, U.S. military spending reached $571 billion, way ahead of the second-spot occupant China’s $129.4 billion. Also, within the U.S., defense made up the largest share of spending, accounting for approximately 54% of all federal discretionary expenditures for fiscal 2015.
Increasing threats and the need to safeguard the interest of nations and people have pushed up demand for U.S. weapons exports, benefiting U.S. defense manufacturers. The ISIS and Syrian conflict, continued saber-rattling by North Korean leadership and high tensions over the disputed ownership of islands in the East and South China Sea are some of the ongoing global flashpoints.
Many of the defense majors are doing a decent job, propelled by the following strategies:
Improving Economy and 2-Year Budget Stability: Per a Treasury Department report, the U.S. budget deficit narrowed to $439 billion in fiscal 2015, the lowest level since 2008, as the economy continued to recover from the financial crisis and revenue growth outpaced a rise in spending. The 2015 deficit dropped to 2.5% of gross domestic product or GDP. This was the lowest since 2007 and less than the average of the last 40 years.
This economic scenario of shrinking deficit is a major change from the $1 trillion-plus annual deficits the U.S. government reported from fiscal 2009-2012 when it boosted its spending to cope with the consequences of the financial crisis.
Consequently, on the eve of Halloween, the U.S. Congress approved a crucial bipartisan budget agreement, in line with the White House. Although it was $5 billion short of the president's 2016 defense budget request, the comprehensive two-year budget deal, unveiled on Oct 26, is expected to give Pentagon planners the fiscal stability they have been pleading for. Not only that, this deal is a reprieve from situations involving government shutdowns and lengthy stop-gap spending measures.
Foreign Military Sales (FMS): The big defense operators are expanding their markets, with foreign sales as a key boost for top-line growth. Driving the demand for foreign sales is a number of escalating regional conflicts, such as, the ongoing Syrian civil war, the unsettled situation in Iraq, Yemen and Libya, and tensions in Eastern Europe. A number of emerging markets as well as nations, such as, India, Japan, the United Arab Emirates, Saudi Arabia and Brazil are increasing defense spending and generating business for the U.S. aerospace and defense companies.
Notably, defense stocks came into the spotlight in recent times as countries in Europe and the Middle East may need to ramp up their defense spending in order to combat the threats posed by the ISIS. Indeed, Britain has planned to boost its defense equipment budget by 7% over the next 10 years. The total budget amounts to approximately $270 billion, including the uplift in equipment spending, nine new Boeing (BA) P8 maritime patrol aircraft and two new strike brigades by 2025.
The U.K. has plans to buy an additional squadron of Lockheed Martin’s (LMT) F-35 fighters for the Royal Navy beyond their original commitment. It had earlier planned to buy 138 F-35 jets, bringing 24 of them into operation by 2023, in a deal worth $18 billion.
In fiscal 2015, sales under the government-to-government FMS Program totaled $35.35 billion, according to the Defense Security Cooperation Agency.
In this regard, it is worth mentioning that foreign military contracts are a vital growth driver for Raytheon Company ( RTN) too. The company has been witnessing a steady rise in international sales over the past few years. International bookings comprised 26% and 37% of total company bookings in the third quarter and the first nine months of 2015, respectively. In the year-ago period, it was a respective 24% and 28%. International sales in third-quarter 2015 accounted for 32% of total sales compared with 30% a year ago. Rising demand from the Gulf countries as well as the Asia-Pacific region will likely be the company’s key revenue driver.
Restructuring/Diversification/ Acquisition: To maintain margins in a tough business environment, companies are squeezing costs out of their operations and diversifying into new business areas. Commercial aviation is one such diversification play, with opportunities in the emerging markets driving the trend.
New macro challenges are prompting industry players to revisit their business models. One such example is Lockheed Martin’s two recent strategic moves – a planned spin-off or sale of its government IT and technical services businesses and the acquisition of Sikorsky. This prime defense contractor became an even bigger aerospace powerhouse as it scooped up Black Hawk helicopter maker Sikorsky Aircraft from United Technologies ( UTX) for $9 billion in cash.
Another defense contractor, Rockwell Collins Inc. (COL) is known to acquire assets having the same line of business, thus helping it to expand its core offerings. The 2013 ARINC Inc. acquisition was a major leap forward for the company. More recently, the company expanded its Information Management Services portfolio by adding Pacific Avionics in Mar 2015.
Next-Generation Technology: At the macro level, there has been a gradual shift in defense spending patterns. In response to asymmetric terrorist threats, the emphasis appears to have shifted to high-tech intelligence equipment, replacing demand for conventional big guns and heavy armor.
The major industry players have, in response, resorted to bolt-on acquisitions to plug gaps in their product offerings. A focus on R&D is also helping these companies to develop next-generation technologies essential in a climate of fewer programs and reduced budgets.
In Oct 2015, Raytheon completed its acquisition of Herndon, VA-based Foreground Security, which is aimed to enhance its cybersecurity and electronic warfare capabilities. Foreground Security is a provider of managed security operations centers and cyber-security services.
In May 2015, Raytheon completed its agreement with Vista Equity Partners LLC to form a new reportable segment, blending its own cyber assets with Websense. The newly formed unit – Raytheon|Websense – combined Raytheon's advanced cyber security technologies and Websense's TRITON platform to come up with a new level of defense-grade cyber security solution.
Northrop Grumman (NOC) is bringing more focus to its airborne and space ISR business by realigning its divisions. In particular, the emphasis is on ISR systems, advanced electronics and software development technologies. It is the proud owner of the popular Global Hawk, an unmanned system with the ability to transform itself into an operational weapons system when required. Northrop also boasts products like the E-2D Advanced Hawkeye, which provides 360-degree surveillance at all times.
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