Monday, July 15, 2013

Investing in Aerospace Defense

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Remember when the Fiscal Cliff was going to destroy defense-related stocks? That was so 40% ago, as my chart below shows comparing the iShares Dow Jones Aerospace & Defense index ETF (ITA) vs. the S&P 500 for the past year.

One year ago, Lockheed Martin CEO Robert Stevens told a House committee that deep Pentagon cuts slated to kick in January 2, 2012 would force his firm and others to fire employees and close factories. It was expected that those moves would hinder U.S. national security, erode defense firms' bench of highly skilled workers, and, of course, cut into weapons-makers' bottom lines.

But the blows never came. In fact, with big guns like Boeing (BA), Lockheed Martin (LMT), and Northrop Grumman (NOC), the ITA really took off in the past 5 weeks.

It makes sense that the suppliers of equipment to large Aerospace & Defense (A&D) companies would be doing well. I looked at these 3 Zacks #1 Rank stocks in the group:

Orbital Sciences (ORB) is a leading space technology systems company that designs, manufactures, operates and markets a broad range of space-related products and services.

Astronics Corporation (ATRO) is a manufacturer of specialized lighting and electronics for the cockpit, cabin and exteriors of military, commercial transport and private business jet aircraft.

HEICO Corporation (HEI) is engaged primarily in certain niche segments of the aviation, defense, space and electronics industries. HEICO's customers include a majority of the world's airlines and airmotives as well as numerous defense and space contractors and military agencies worldwide in addition to telecommunications, electronics and medical equipment manufacturers.

Zacks Investment Research picked HEICO for "Bull of the Day" for two reasons. First, their projected earnings and sales growth of 19% and 13% respectively.

Secondly, the fact they have a diverse mix of products, target markets, and customers, beyond A&D. In other words, commercial and general aviation, not just the space program or the military. They even serve computer, electronics, and healthcare markets.

On May 22, the $2.9 billion company reported strong quarterly results and raised guidance. In the chart below, you can see the resulting breakout above $47 on strong volume.

On May 24, upward EPS estimate revisions from analysts caused HEI to become a Zacks #2 Rank (Buy). On June 27, when HEI was still trading below $51, it became a Zacks #1 Rank (Strong Buy).

Head-to-Head on All the Metrics

One great resource in the Zacks Premium tools is the ability to compare industry peers on dozens of fundamental metrics. Here's a snapshot of these 3 companies from the Earnings view.

What stands out is that HEICO is more expensive on a valuation basis. But if the global trends of commercial aviation expansion continue to favor the fortunes of companies like Boeing, HEICO should be along for the flight.

But, what about that Boeing 787 fire at Heathrow on Friday? We'll get to that in a moment.

Here is how HEICO structures itself in two primary business segments...

The Flight Support group designs, engineers, manufactures, repairs, distributes and overhauls FAA-approved parts that extend over the entire aircraft, from the engines all the way to hydraulic, pneumatic, electromechanical, avionic, structures, wheels and brakes and even interiors.

The Electronic Technologies group produces electrical and electro-optical systems and components serving niche segments of the aerospace, defense, communications, and computer industries.

Boeing 787 Woes: Where There's Smoke...

This week should be an interesting one for many of these A&D stocks after the damage to Boeing shares on Friday. A 787 runway fire at London's Heathrow airport sent the stock down over $8 (7.5%) in less than 20 minutes on the news.

But BA shares bounced off of $99 to close just below $102, down only $5 (4.7%). Not terrible considering it just made new all-time highs Friday above $108, eclipsing the record highs set in July 2007 above that mark.

The good news for HEI shares is that they only fell 1% and are still within 1% of their closing all-time high just below $55. Going forward, I would trade any of these A&D equipment makers in tandem with their large-cap A&D customers.

In other words, as the big guns of the sector go, so go the suppliers. Right now, I like HEI the best for its sold growth, diverse products and customers, and a strong price chart.

If Boeing can put out their fires, HEICO should be a good wing man.

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