After Obama’s signing on defense sequestration and budget cuts, many have formed a bearish point of view on the aerospace and defense stocks. Let’s see if this point of view needs to be rectified to some extent.
The following organic growth rates are expected for each of the company’s segments:
(1) Information Systems down 10%,
(2) Aerospace Systems down 2%,
(3) Electronic Systems down 1%
(4) Technical Services down 9%
The company is expected to burn a free cash flow of $200 billion. This has been the norm in the first quarter of the year, given the seasonality of Northrop Grumman Corporation (NYSE:NOC)’s free cash flow generation.
What causes worries?
The quarterly outlook on the segments looks horrific. Every segment is going to witness a decline in the top-line.
It is interesting to note that Northrop Grumman Corporation (NYSE:NOC)’s guidance for 2013 does not include the impact from sequestration. The company may choose to now include it, which would lower numbers; or it may choose to hold the current assumptions until the timing and size of a sequestration impact is more visible. Goldman thinks the latter is more likely.
Focus items
Analysts will like to know what the company has to say about:
Sequestration
Margins
Free cash flow generation
Capital deployment priorities
Well, the next stock under discussion is 787. You have obviously guessed that it’s The Boeing Company (NYSE:BA), and if you haven’t then perhaps this post is not for you since 787 fiasco has been the hottest topic in the aerospace industry. The aerospace giant will report on April 24, and the Street expects the company to report EPS of $1.48, which according to The Boeing Company (NYSE:BA) is GAAP EPS + unallocated pension expense per share.
However, this estimate doesn’t seem to reflect the The Boeing Company (NYSE:BA) Defense segment’s (BDS) revenue, which is expected to be down by 8% for the year. This is another hit to the aerospace company due to defense budget cuts. EPS is expected to be $1.45.
Other important highlights for the quarter are:
1) The Boeing Company (NYSE:BA) reported 137 aircraft deliveries in 1Q13, including one 787 delivery.
2) The Boeing Company (NYSE:BA) booked 209 net new aircraft orders in the quarter, implying a book-to-bill ratio of 1.53 for the commercial aircraft segment.
Then what?
Boeing is expected to reiterate its 2013 EPS guidance, given it is early in the year. Moreover, the 787 issue has been settled, and hence no changes will be made to the 787 delivery schedule. Though, it is interesting to note that a change in the 787 schedule would have hardly caused any change to the EPS given the low profit margin of the program.
Focus items
2013 new aircraft order expectations
Sequestration and the Defense budget
Cash flow generation and capital deployment
Next-generation aircraft product strategy
So are we convinced that sequestration matters?
Just to check whether budget cuts have really dented the outlook of aerospace stocks with exposure to defense spending, I chose to preview the earnings of B/E Aerospace Inc (NASDAQ:BEAV), a pure-play on commercial aircraft demand. And guess what? The market is right. Budget cuts have definitely been the main culprit behind low year-to-date gains on these stocks.
B/E Aerospace Inc (NASDAQ:BEAV) is currently on Goldman’s conviction buy list. The company is expected to beat the earnings estimate on the back of higher than expected Inter-turbine revenue. Its Commercial Aircraft and Business Jet businesses are expected to grow by mid-to-high single digit figures for the year. The book-to-bill is expected to remain greater than 1.0x for 2013.
There is some room for the guidance to be revised upwards, but BA Aero doesn’t normally do so at the start of the year. Still, the company is expected to provide an upbeat update on its outlook for 2013 orders, new Aerospace supplier furnished equipment (SFE) wins (both OE and retrofit), general aftermarket trends, and capital deployment opportunities. The company will likely provide a recap of the Hamburg Aircraft Interiors Show, including overall order strength and SFE opportunities.
Focus items
Aftermarket trends
Airline ordering patterns
SFE production ramp
Capital deployment priorities
Final word
Defense budget cuts have definitely had a far-reaching impact on stocks with defense exposure. Moreover, this season’s earning calls will provide more color on further probable cuts. However, to say that every stock with an exposure to defense spending is a sell would be totally unjustified. Every company has its own story, and nothing can be decided before carefully analyzing whether growth in a company’s other segments can help to offset declining defense revenues.
The article Sequestration: Is it a Valid Reason to Short the Aerospace industry? originally appeared on Fool.com and is written by Masam Abbas.
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