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Zacks Industry Outlook Highlights: Lockheed Martin, Hexcel, Triumph Group, FLIR Systems and AAR

For Immediate Release

Chicago, IL – April 14, 2016 – Today, Zacks Equity Research discusses the Aerospace/Defense, (Part 3), including Lockheed Martin (LMT), Hexcel Corp. (HXL), Triumph Group, Inc. (TGI), FLIR Systems, Inc. ( FLIR) and AAR Corp. (AIR).

Industry: Aerospace/Defense, part 3


Granted that economic data has turned more positive lately and geopolitical uncertainty has improved the outlook for the broader defense space, there are still certain issues holding back the sector. A faster-than-expected rise in interest rates and "disproportionate" cuts to modernization and research and development funding could act as major impediments for a defense industry that is already facing major volatility.

Below we have discussed the headwinds that might spoil the prospects of the aerospace and defense sectors in the near term.

Strong U.S. Dollar: A gradually recovering U.S. economy, slower global growth and expectations of more rate hikes from the U.S. Federal Reserve have led to the U.S dollar appreciation. This has affected U.S.-based companies as the strong dollar is not only showing up as a currency translation drag, but is also having a bearing on foreign military sales.

Although the Fed has held itself from raising interest rates again given market jitters as well as a sharp slowdown in China, it will ultimately resume rate hikes. It has kept its benchmark rate at a record low for seven years. The dollar is expected to gain further from a series of rate hikes that the Fed is planning. A stronger dollar could damage U.S. export competitiveness.

Will Weapons Programs Be Hit in Fiscal 2017 Budget?

As expected, the U.S. Department of Defense (DoD) announced this February that it plans to purchase fewer F-35 fighter jets from Lockheed Martin ( LMT) over the next five years than it had originally planned. The Pentagon’s next five-year plan, beginning fiscal 2017 through fiscal 2020, covers the purchase of 299 jets (down by 37 units from the previous expectation). Total funding – procurement, research, and development – drops from $11.602 billion in FY 2016 to $10.504 billion in the FY 2017 proposal.

Certain limitations on the budget related to training, personnel costs and force structure may have an implication on weapons programs in the fiscal 2017 budget plan.

Lockheed Martin's F-35 fighter jet is undoubtedly the single largest weapons program of the DoD. Apart from that, total funding proposal for the P-8A Poseidon program – procurement, research, and development – in FY 2017 dropped to $2.165 billion from $3.373 billion in FY 2016. Funding proposal for fiscal 2017 for Stryker, the Amphibious Combat Vehicle (ACV), DDG 51 Arleigh Burke destroyer along with Space Based Infrared System (SBIRS) and the DoD’s Global Positioning System (GPS) program has also witnessed a sharp decline as well.

Some defense suppliers may have to migrate their business models toward other channels to offset the secular decline in weapons-related procurement.

Economic Picture: The U.S. has been the world’s largest defense consumer since World War II. Iraq and Afghanistan wars in the past decade boosted spending, driving it to historic heights. However, the winding down of those wars and severe pressure to lower the national debt burden following the country’s major financial distress since the Great Depression had cast a long shadow over the U.S defense budget. Although the defense market received the latest two-year budget deal with much enthusiasm as it brought military stability, one cannot overlook the risk of an economic downturn.

A country’s ability to spend on defense is a function of its economic health. The same is true at the global level – the faster the global economy grows, the higher will be the defense spending. Following the global crisis in 2008, there was a marked shift in defense spending growth from the developed to the emerging countries.

Notably, the overall U.S. economy, as measured by gross domestic product or GDP, increased at an annual rate of 1.4% in the Oct–Dec 2015 period, per the "third" estimate released by the Commerce Department. This was down from the third quarter’s 2% growth rate.

U.S. economic growth came to a complete halt in Q1, per Atlanta Fed's GDPNow model. It now shows Q1 GDP growth of just 0.1%, down from a 0.4% earlier estimate.

Intense Competition: Aerospace and defense companies compete among themselves for a finite number of small and large programs.

Moreover, China is flexing its military muscles and is developing space technologies aimed at blocking U.S. military communications, per a report commissioned by a panel formed by the U.S. Congress. China’s goal is to become a space power as forceful as the U.S. and to promote a space industry equal to those in the U.S., Europe and Russia.

Given the looming headwinds, we advise investors against names that offer little growth/opportunity over the near term. These include companies for which estimate revision trends reflect a bearish sentiment.

We remain apprehensive of Zacks Rank #4 (Sell) stocks like Hexcel Corp. (HXL), Triumph Group, Inc. (TGI) and FLIR Systems, Inc. ( FLIR).

In addition, we are skeptical of Zacks Ranked #5 (Strong Sell) stocks like AAR Corp. ( AIR).

Our Take

In “ Will Defense Turn Green on Boosts to Military Spending? ” we focused on the conditions which are expected to drive the industry forward.

The industry's position is now challenged by global competition, changes in technology, national and worldwide economic conditions and global policies affecting defense, civilian and commercial aviation.

The fast-changing world with rising global uncertainty requires the defense sector to act with speed and flexibility. With careful management and prudent spending the sector is expected to weather the headwinds effectively.

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LOCKHEED MARTIN (LMT): Free Stock Analysis Report
HEXCEL CORP (HXL): Free Stock Analysis Report
TRIUMPH GRP INC (TGI): Free Stock Analysis Report
FLIR SYSTEMS (FLIR): Free Stock Analysis Report
AAR CORP (AIR): Free Stock Analysis Report
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