3 aerospace and defence stocks to buy

Feuding aircraft manufacturing stocks Boeing and Bombardier could co-exist quite happily in your portfolio says New-York-based Credit Suisse analyst Rob Spingarn. Perhaps that prompted some thinking of the need for surveillance solutions providers since he includes information technology stock Harris Corp. into his 3-pack of best stocks to buy.

Aerospace_and_Defence_StocksEarly this year, aircraft manufacturers Bombardier Inc. (TSX—BBD.B) and Boeing Co. (NYSE—BA) made ink in both their home countries due to the latter’s complaint that the former enjoyed too much government support.

Despite the international dispute, analyst Rob Spingarn suggests that the two could co-exist peacefully in investors’ portfolios. He touts them as among his ‘best buys’ for aerospace and defence stocks, along with Harris Corp. (NYSE—HRS). The New York City-based analyst serves as senior equity analyst and global head of research for those industries at Credit Suisse.

Boeing had complained that Bombardier held an unfair market advantage because its C Series regional jets were built with too much financial support from the Canadian and Quebec governments. In 2016, Delta Air Lines made a firm order for 75 of the aircraft, which seat between 110 and 130 passengers.

Boeing does not sell any models that directly compete with the C Series. Nevertheless, the US Commerce Department recommended imposing duties of almost 300 per cent on C Series aircraft for five years, which would have driven Delta to cancel its purchase.

Somewhat surprisingly (at least to many Canadian observers), the US International Trade Commission unanimously rejected the recommendation in January, citing no lost sales on Boeing’s part after the Delta order and allowing the sale to go ahead.

Despite their massive differences in market capitalization, product offerings and market share, Mr. Spingarn’s rosy prognoses for aircraft giant Boeing and underdog Bombardier are both based largely on the promise of new aircraft.

Airbus will add scale, global reach to C Series

Since the resolution of Boeing’s complaint, European aerospace corporation Airbus SE has taken a majority stake in the C Series project, adding scale and an international market presence while bolstering investor confidence.

“We believe additional C Series orders are likely following the joint venture with Airbus,” he says, which closed before the Farnborough Air Show in the UK in July, the premier European aerospace industry event.

Mr. Spingarn outlines several reasons in his case for Bombardier.

“We believe in the turnaround story, and note that this management team has consistently hit targets during its first three years.

“Beyond C Series, other businesses are improving with Bombardier Transportation’s (the company’s rail segment) backlog and sales expanding nicely.” He also points out that Bombardier Transportation, as well as its business jets and its aerostructures segments, are all enjoying solid margin improvement.

Finally, the analyst adds: “Even after the seven per cent dilution from a US$500-million equity offering in March, shares remain extremely attractive on our 2020 forecast. Specifically, it currently trades at about five times 2020 estimated EV/EBITDA.”

Discussing Boeing, Mr. Spingarn says its price-to-earnings ratio could expand “as cycle concerns diminish with high traffic, and cyclicality abates with a growing service business. We also expect additional margin upside from management’s focused strategy on cost control and service or life cycle opportunities.”

The analyst forecasts a production rate for the Boeing 787 model of 12 per month, while keeping the 777 at 3.5 per month, and increasing the rate for the 737. “We model the rate rising to 57 a month in 2019, based on Boeing’s intention, and we feel comfortable that the current backlog can support this rate through at least 2022.

“Separately, upcoming catalysts include the third-quarter earnings in October, where Boeing will formally roll out financials for its new Boeing Global Services reporting segment.”

Technology stock provides defence and IT systems

Mr. Spingarn’s third ‘best buy’, Harris, makes products that are more varied than those of his other selections. Harris is a US technology defence contractor and information technology services provider. Its three business segments are communication systems, electronic systems, and space and intelligence systems.

It produces wireless equipment, tactical radios, night-vision equipment and both terrestrial and space-borne antennas. Specialties include surveillance solutions, microwave weaponry, air traffic management, space and intelligence, and weather solutions. The manufacturing stock generates about US$7 billion in annual revenue.

The analyst says: “Following our recent revaluation of the defence sector, our discounted cash flow analysis on Harris resulted in upside potential near the top of the pack, and valuation still appears attractive at this level. We also like HRS for its relatively high proportion of international sales and exposure to shorter-cycle readiness spending.”

This is an edited version of an article that was originally published for subscribers in the August 10, 2018, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.

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