Opportunities In Aerospace And Defense

May 14, 2022 8:27 AM ETASLE, LMT, TDG, BYRN, AERG, ESLT, PKE, AIR, NPK, ERJ, BDRAF, BDRBF, LILM, RADA, BBD.A:CA, BBD.B:CA2 Comments
Shelley Goldberg profile picture
Shelley Goldberg
364 Followers

Summary

  • On May 10, 2022, the U.S. House passed a $40 billion Ukraine package to provide military and humanitarian aid.
  • Despite the almost daily sanctions placed on Russia by governments around the world, this war looks to continue for some time.
  • The sector includes manufacturers of civil or military aerospace and defense equipment, parts or products, including defense electronics and space equipment.

Jet fighter on an aircraft carrier deck against beautiful sunset sky .

NanoStockk/iStock via Getty Images

On May 10, 2022, the U.S. House passed a $40 billion Ukraine package to provide military and humanitarian aid. That news, along with the announcement that seven European nations have increased their defense budgets in one month, are reasons to consider an investment in defense.

Biden's request represents a remarkable escalation in U.S. investment in a Russian-provoked war, and is more than triple the total of U.S. emergency expenditures. According to the New York Times, passage of the bill would put the U.S. on track in 2022 to spend as much, if not more, helping Ukraine, as it did on average each year fighting its own war in Afghanistan.

Despite the almost daily sanctions placed on Russian by governments around the world, this war looks to continue for some time, with Putin showing no signs of giving in. What this also means is that it is not too late to invest in defense.

The defense sector, referred to as Aerospace & Defense (A&D), is a subsector of the Industrials. A&D includes manufacturers of civil or military aerospace and defense equipment, parts or products including defense electronics and space equipment. For diversification, one can choose names that fall under different categories within A&D. For example, Lockheed Martin Corp (LMT) is principally engaged in advanced technology systems, products and services, while TransDigm Group (TDG) is a manufacturer of aerospace components and systems.

Whether an investor is a customer of a full-service bank or of a discount brokerage, there are many tools available when it comes to security selection. Of a universe of all internationally listed equities [1], there are 57 A&D names that represent a combined enterprise value of $89.91 billion, as of May 12.

The P/E (GAAP Actual) ratio of the industry was 33.75 last year, [2] compared to this year's estimate of 30.76. As the P/E ratio is used to gauge the valuation of a stock or index, the higher the ratio, the more expensive the stock relative to its earnings. This drop in valuation means that the sector is expected to be less expensive this year thus providing greater value than last year.

The trailing-twelve-month ROI for the sector was 9.54% as compared to the S&P 500 which, on average, is around 10.50%. ROI measures how effectively a company uses its capital to generate profit, and it comes hand in hand with risk. With greater risk comes the potential for higher rewards.

Returns of the Aerospace & Defense sector and the S&P 500 Index (SPX) as of May 12, 2022.

YTD

1YR

3YR

5YR

Aerospace & Defense

-0.96%

-2.53

-3.11%

+29.78

S&P 500 Index

-17.54%

-5.35

+36.39

+64.13

While A&D outperformed the market over the last year, it underperformed the market in the last 3 and 5-year periods. Thus, while A&D's returns are far from stellar relative to better-performing sectors (e.g., technology), it may be a ripe time to buy weakness within A&D. Finally, the sector can be considered a diversifier to a larger portfolio.

The following criteria can serve as useful tools when selecting names. None should be considered in isolation but rather in conjunction with other factors such as fundamental data, growth, profitability and technical (charting) aspects. Data is as of May 12, 2022.

Market Capitalization: When it comes to market cap, bigger is not necessarily better. One has a choice ranging from large-cap down to micro-cap. Valued at $136.05 billion, Raytheon Technologies (RTX) has the largest capitalization, as compared to microcap, Byrna Technologies, Inc. (BYRN) with a $139.78 million valuation.

Total Return (1 YR Ann): Applied Energetics Inc. (OTC:AERG), up 236.59%, followed by Elbit Systems Ltd (ESLT) at 57.07%. Note that a company does not necessarily need to make money to perform well, particularly if it is in the early stages of development.

Equity Summary Score (ESS): There are many independent equity research experts. StarMine from Refinitiv, for example, ranks equities on a scale of 1 to 10. They awarded their highest score, a 'very bullish' 9.9, to Park Aerospace Corp (PKE), followed by a 'bullish' 8.6 to AerSale Corp (ASLE) and 8.4 to ARR Corp (AIR).

Dividend Yield: Some investors prefer dividend-paying stocks. The highest dividend yield belongs to National Presto Industries (NPK) paying 6.42%. Of the list of 57 names, currently 23 pay dividends.

Domicile: To add international diversification to a portfolio, consider companies outside of the U.S. In America, there's Brazil-based Embraer SA (ERJ) and Canada's Bombardier Inc (OTCQX:BDRAF) (OTCQX:BDRBF). In Europe, consider Germany's Lilium NV (LILM) and in the Middle East, there's Israel's RADA Electronic Industries Ltd (RADA). Of the 57 names, 11 have headquarters outside the US.

Options (Calls & Puts): Many investors prefer companies with options, which can be used for hedging or trading purposes. Of the 57 names, 36 offer options. Options are advisable only for sophisticated traders.

Innovation, R&D: Focus on innovation and new technologies. Digital thread and smart factory could move into the mainstream of A&D company operating systems in 2022, according to a study by Deloitte. Furthermore, innovation is to continue accelerating growth in the space market.

Risks: Like any investment, understand the risks. While it is important to focus on military orders supporting the Ukraine resistance such as Raytheon's Javelin and Stinger Missiles, there are still Covid-related supply chain issues affecting the flow of raw materials that go into the manufacturing of these weapons, causing bottlenecks and delays in their deliveries.

Leave The Work To Others

Some investors do not have the time or resources to make stock selections. Rather than going through the exercise, an easier route is to buy an ETF (Exchange Traded Fund), a basket of securities that track an index. Two examples are the iShares U.S. Aerospace & Defense ETF (ITA) and the SPDR® S&P Aerospace & Defense ETF (XAR).

Other choices include mutual funds and indexes.[3] The Fidelity Select Defense and Aerospace Portfolio (FSDAX) is a mid-cap value mutual fund. Currently, this fund has no direct U.S.-listed competitors. Mutual Funds are typically actively managed funds. For passive portfolios, consider indexes, such as the Aerospace & Defense Select Industry Index (SPSAID).

Bottom line - A&D's lower valuations combined with soaring US and European defense spending makes for a ripe opportunity to invest in defense.


[1] All internationally listed stocks, excluding OTC and pink sheet stocks.

[2] The most recent fiscal year

[3] While ETFs, like equities, can be traded intra-day, mutual funds and index funds can only be traded at the set price point at the end of the day.

This article was written by

Shelley Goldberg profile picture
364 Followers
Shelley Goldberg is an investment advisor and strategist in environmental sustainability and the Founder and Principal of Invest-With-Purpose. Having structured and managed portfolios for over 20 years, she runs a consultancy and investment management practice with an embedded ESG focus. She has served as a macroeconomic strategist, trader, and investment advisor for multi-asset portfolio managers, including her own energy fund, G3 Capital Partners, LLC, and the largest fund-of-funds devoted to natural resources with Swiss private bank, Union Bancaire Priveé. She served as an Investments Strategist for Brevan Howard Asset Management LLP, a 42 billion-dollar hedge fund, and for Roubini Global Economics. Today she takes on leadership roles in impact investing with the goal of monetizing developments in environmental sustainability. She publishes frequently on resource sustainability topics and is often invited to speak or participate in panels at industry conferences. She is featured on television and online forums as an expert in commodities and impact investing. Shelley graduated from Tufts University, earning a Bachelor of Arts degree in political science and Spanish and received a Master of Business Administration from New York University Stern School of Business in finance and international business.

Disclosure: I/we have a beneficial long position in the shares of ASLE either through stock ownership, options, or other derivatives. 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.

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