Aerospace/Defense: Some Opportunities Available

Includes: AAON, GD, HXL, TGI
by: Zacks Investment Research

With the U.S. presidential election beginning to take shape, we thought we would start a discussion with Zacks senior aerospace and defense industry analyst John Nelson Simon about whether or not his industry outlook has gotten any clearer at the present time.

We know high fuel prices have been taking a toll on airlines recently, but have you seen any negative impact on the airline suppliers under your coverage?

The only suppliers that have been seriously affected are those where most of their revenues come from OEM (original equipment manufacture) as opposed to MRO (maintenance, repair and overhaul, aka the after-market). An example would be Hexcel (NYSE:HXL), which makes a variety of structural materials and assemblies for new-aircraft. Obviously, that is primarily the result in the slippage of new aircraft deliveries, particularly the A380 and 787, not the airlines cutting back on MRO or new-airplane orders (yet).

If anything, after the recent FAA fiasco, there is more MRO going on, not less. However, we will continue to see the airlines ground older, less-fuel-efficient aircraft as they replace them with newer models -- or not, in some cases like Delta/Northwest (NYSE:DAL)/(NWA) or potentially United/USAir (UAUA)/(LCC). Keep in mind that a lot of airlines aren't in the U.S. and many of them are doing quite well, particularly most of the airlines in the Middle East, India, China and even Russia, where they have a natural-resources surplus.

With the presidential election coming in the fall, the picture has become clearer with regard to the two parties' candidates. Does this shed any light on the defense industry looking ahead, in your view?

No! In fact, it makes the outlook extremely murky for defense. If McCain gets in, he's going to have to fight a Democratic congress that wants to bring the troops home...but isn't sure. If Obama gets in, he's going to bring the troops home and slash defense spending...maybe!? If Clinton gets in, she's going to...?

Where do you see the biggest strength presently, within the industries you cover?

The after-market [MRO] is generally strong...both for commercial as well as defense. Consequently, acquisitions continue.

Which companies would you consider your top Buy recommendations at this time?

I have a Buy on AAON, Inc. (NASDAQ:AAON) in my E&C group. I haven't completed all my update reports yet, but I did have a Buy on Triumph Group (NYSE:TGI) in my Aerospace/Defense group; that may change when I do the update, so keep a wary eye out for it. Otherwise, they're all Holds. My one short - Force Protection (NASDAQ:FRPT) - went from $36 to $2).

Are there any areas investors should steer clear of? What is your general advice to investors regarding the overall aerospace/defense group in the near term?

Presently, the United States is engaged in an attempt to pacify a massive, unruly population. Our more-recent history indicates a lack of success with such endeavors. The Korean encounter deteriorated into a continuing standoff. The Vietnamese engagement ended with our withdrawal. Our current effort is being questioned, and our path appears precarious. All this brings a degree of uncertainty into the arena of investing in the Defense Sector. Specifically, if we do not achieve our recently stated objective of assuagement, what effect will that have on the fortunes of the enterprises that are providing goods and services to the military establishment?

In the near-term, probably nothing will change much. However, further down the line, watch out for the light at the end of the tunnel…for it could be the termination express.

John Nelson Simon is a senior analyst covering the aerospace and defense industries for Zacks Equity Research.