Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Aerospace & Defense Stocks Survive 2011

|Includes:BA, GD, LMT, NOC, PowerShares Aerospace & Defense Portfolio ETF (PPA), RTN
Aerospace & Defense Stocks Survive 2011
 
The year saw a constant flow of negative news regarding the defense sector as the media focused on U.S. budget and debt-reduction issues that threatened to decimate spending at the Pentagon. Combined with the pullout of troops from Iraq the peak in defense spending that many waited for arrived. Yet when the dust settled, the Aerospace & Defense sector held steady with the broader market. Yes, that’s right; 2011 saw the SPADE Defense Index decline by just 2.75% vs. the flat performance by the S&P500.
 
2011 Performance of the Largest Defense Prime Contractors
 
Lockheed Martin (NYSE:LMT)
15.72%
Boeing (NYSE:BA)
12.40%
General Dynamics (NYSE:GD)
[6.41%]
Northrop Grumman (NYSE:NOC)
[9.73%]
Raytheon (NYSE:RTN)
4.40%
L-3 Communications (NYSE:LLL)
[5.41%]
Click to enlarge
 
Although still down nearly 25% from its peak in October 2007, the Powershares Aerospace & Defense ETF (NYSE: PPA) and the SPADE Defense Index (NYSE: DXS) which it tracks, has mimicked the movement of the broader market closely over the passed two years following a decade-long run between 2000-2010 when the sector outperformed the broader market by more than 100%, returning 178%.
 
Historical Performance
 
SPADE Defense Index (NYSE: DXS)
S&P 500
2011
[2.75%]
0.00%
2010
9.61%
12.78%
2009
21.71%
23.45%
2008
[38.03%]
[38.49%]
2007
22.17%
3.53%
2006
19.33%
13.62%
2005
5.30%
3.00%
2004
20.47%
8.99%
2003
37.27%
26.38%
2002
[2.87%]
[23.37%]
2001
0.94%
[13.04%]
2000
4.98%
[10.14%]
Click to enlarge
 
In a year that featured significant market swings, the top performing stocks for the year were led by firms that were acquired earlier in the year – EMS Technologies, SRA International, Goodrich, and Integral Systems.
 
 Top Performing Stocks – 2011
1
EMS Technologies*    
66.23%
2
SRA International*
51.20%
3
Goodrich*
40.46%
4
OSI Systems
34.16%
5
Hexcel 
33.83%
6
Transdigm
32.87%
7
Teledyne Tech.
24.74%
8
Integral Systems*
22.81%
9
Precision Castparts
18.38%
10
Aerovironment
17.29%
Click to enlarge
acquired
 
Worst Performing Stocks - 2011
1
Kratos Defense
[54.67%]
2
Computer Sciences
[52.22%]
3
Key W Holding
[49.56%]
4
NCI Information
[49.33%]
5
GeoEye
[47.58%]
6
Digital Globe
[46.04%]
7
Ducommun
[41.46%]
8
Oshkosh Truck
[39.33%]
9
AAR Corp
[30.21%]
10
Mercury Computer
[27.69%]
Click to enlarge

With the P/E, price-to-sales, and price-to-book of many A&D firms below those of the broader market and with dividend yields of many firms between 2% and 4%, and there is hope by some investors that a reversion to the mean indicates upside potential.
 
Where we are
Analysts and industry executives have known for some time that a peak in defense spending was coming and a flat- to down budget environment would make it necessary for firms to position themselves accordingly; investing into higher growth areas and expanding internationally. Although the defense budget is under pressure, the past weeks have seen multi-billion contracts issues for fighter aircraft, missile defense systems, etc.
 
Meanwhile the commercial aerospace sector is beginning to hit on all cylinders. The introduction of new projects into the market, expansion by airlines around the globe, and the need to replace aging aircraft with newer, more fuel efficient vehicles have put the sector at the beginning of a decade-long upcycle with backlog at record levels.
 
Cybersecurity and UAVs, once only discussed among those that followed the defense sector, have received prominence in the mainstream as attacks against computer networks and security installations continue to rise. 
 
Overall, there are a number of analysts and investors who think the valuations of A&D firms remain very attractive. With 2012 being a U.S. presidential election year, we should see a more moderate stance on budget cuts to the defense sector and the draconian measures proposed by some will be deemed irresponsible. Healthy dividends, buybacks, an increase in international sales as foreign nations cut back on internal development to reduce costs, a booming commercial aerospace market, and, I believe, a recovery in the U.S manufacturing sector could all lead to results in 2012 that surprise to the upside. There is, however, still an element of considerable risk as the government debates how best to reduce its budget deficits. Some think the bottom could be in and some think we’ll need a clear and present danger to see an upside. That is the joy of investing – balancing the risk vs. the reward. 

Results showing the 2011 performance of all companies currently in the SPADE Defense Index can be found in the January 2012 edition of 'The SPADE Investor"  newsletter found at www.spadeindex.com
Stocks: PPA, LMT, GD, RTN, BA, NOC