Aerospace And Defense ETFs Will Be Huge Winners When Trump Takes Office

| About: iShares U.S. (ITA)
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Summary

The political environment favors investment in the Aerospace and Defense industry.

ITA and PPA appear to be better positioned than the S&P 500 in general for a rising interest rate economic environment.

Technical analysis shows there doesn't appear to be any significant advantage to waiting, as a breakout could happen at any time.

My preference is to hold ITA, but PPA is also a good choice, despite the fact that the management fees are slightly higher.

Back in September, President-Elect Trump spoke to the Union League of Philadelphia, promising to undo defense spending cuts made during the 2013 budget sequester. Trump has proposed to boost defense spending during the next ten years by more than $500 Billion. The spending will include:

  • development of a state of the art missile defense system
  • modernization of naval cruisers to provide Ballistic Missile Defense capabilities
  • building up the Navy to 350 surface ships and submarines
  • building up the Air Force to at least 1,200 fighter aircraft

It is not surprising that with Trump's surprise election victory on Nov. 7, the three Aerospace and Defense ETFs iShares U.S. Aerospace & Defense ETF (BATS:ITA), SPDR S&P Aerospace & Defense ETF (XAR), and PowerShares Aerospace & Defense Portfolio ETF (PPA) immediately responded by gains of approximately 9% over the subsequent week. Two months after the election they are up 11% and in a consolidation phase which is normal after a significant breakout.

The ITA chart (above) illustrates the original Nov 8 breakout, consolidation phase, and expected breakout from the consolidation. Note: the price charts for XAR and PPA are almost identical.

Checking Under the Hood

I believe that capital strength rules, which are used as selection criteria by the (unrelated) First Trust Capital Strength ETF (NASDAQ:FTCS), serves well in a rising interest rate environment which is expected going forward. The capital strength criteria are as follows:

  • at least $1B cash and cash equivalents
  • Long Term Debt to Market Cap ratio less than 0.3
  • Return on Equity greater than 15%

ITA Top Ten Stocks

Company

Cash

Debt/MC

ROE

Pass

Boeing

$9.668B

0.10

97.18%

Yes

Rockwell Collins

$0.340B

0.12

36.78%

No

General Dynamics

$2.303B

0.07

27.38%

Yes

L3 Technologies

$0.411B

0.24

8.72%

No

Lockheed Martin

$2.895B

0.19

145.13%

Yes

Northrop Grumman

$1.103B

0.15

37.23%

Yes

Raytheon

$2.804B

0.12

21.58%

Yes

TransDigm Group

$1.587B

0.73

N/A

No

Textron

$0.739B

0.28

16.49%

No

United Tech.

$7.107B

0.22

12.68%

Yes

Of the top ten ITA holdings, four stocks don't meet the capital strength requirements.

XAR Top Ten Stocks

Company

Cash

Debt/MC

ROE

Pass

Boeing

$9.668B

0.10

97.18%

Yes

B/E Aerospace

$0.125B

0.33

238.9%

No

BWX Technologies

$0.065B

0.11

67.51%

No

Huntington Ingalls Industries

$0.957B

0.14

27.12%

No

Orbital ATK

$0.073B

0.3

13.38%

No

Raytheon

$2.804B

0.12

21.58%

Yes

TASER International

$0.096B

0

11.04%

No

TransDigm Group

$1.587B

0.73

N/A

No

Textron

$0.739B

0.28

16.49%

No

United Tech.

$7.107B

0.22

12.68%

Yes

Of the top ten XAR holdings, seven stocks don't meet the capital strength requirements. Also of note is that four of the ten stock have very low cash and equivalents, less than $100M.

PPA Top Ten Stocks

Company

Cash

Debt/MC

ROE

Pass

Boeing

$9.668B

0.10

97.18%

Yes

Ball

$0.645B

0.58

11.18%

No

General Dynamics

$2.303B

0.07

27.38%

Yes

Honeywell International

$6.431B

0.11

26.9%

No

Lockheed Martin

$2.895B

0.19

145.13%

Yes

Northrop Grumman

$1.103B

0.15

37.23%

Yes

Raytheon

$2.804B

0.12

21.58%

Yes

TransDigm Group

$1.586B

0.73

N/A

No

Textron

$0.739B

0.28

16.49%

No

United Tech.

$7.107B

0.22

12.68%

Yes

Of the top ten PPA holdings, four stocks don't meet the capital strength criteria, thus PPA won't be considered further.

How Do ITA and PPA Compare to the Stocks Comprising the S&P 500?

Aggregate values were calculated for the entire universe of S&P 500 stocks in addition to the top ten stocks in the remaining two ETFs, ITA and PPA. The aggregates consist of average values with outliers tossed out to avoid skewing the average. The results are as follows:

Company

Cash

Debt/MC

ROE

ITA

$1.905B

0.17

35.62%

PPA

$2.853B

0.18

34.20%

S&P 500

$1.665B

0.26

15.08%

Based on average values, both the ITA and PPA top ten stocks soundly trounce the universe of S&P 500 stocks for ROE. PPA appears to be better positioned than ITA in terms of cash and equivalents.

ETF Properties

ITA

PPA

Assets Under Management

$1.662B

$430M

Average Daily Trading Volume

267142

144349

Net Expenses (%)

0.44

0.64

For some, management expenses are the most important concern. ITA has lower management expenses at 0.44%, 0.20% better than PPA. ITA also has more assets under management and higher trading volume, which should lead to better trade execution.

In my opinion, ITA is the better choice of ETF, given lower management expenses and greater assets under management, understanding that there may be slightly higher risk going forward due to less cash on hand in a rising interest rate environment.

Summary

The political environment favors investment in the Aerospace and Defense industry. Both ITA and PPA appear to be better positioned than the S&P 500 in general for a rising interest rate economic environment. Technical analysis shows that there doesn't appear to be any significant advantage to wait as a breakout could happen at any time. My preference is to hold ITA, but PPA is also a good choice, understanding that the management fees are slightly higher.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.