Morgan Stanley’s 1/7 Big Ideas For 07: Aerospace & Defense

By Yaser Anwar, CSC of Equity Investment Ideas

I came across an interesting report pertaining to ideas that MS believes will do well in 07. In the coming days I’ll post what they talk about and a what I think, thanks for reading.

Theme #1– Aerospace & Defense

• Aerospace and Particularly Defense (repeat from ’06). We have held an overweight position in the aerospace and defense sector since we rolled out coverage in 2004. What we find compelling is that this group (Boeing in particular and suppliers such as Rockwell Collins and Spirit AeroSystems) is a back-door play into globalization, including China.
• If you do not believe me, just visit Asia and you will see surging demand for wide-body products (and let us not forget that they are five times as profitable as narrow-body aircraft, according to our analyst Heidi Wood). Defense, which Heidi also covers, is compelling for several reasons, we believe.
• For starters, investor interest remains just lukewarm, despite the group’s reliable outperformance year after year (the group has outperformed the S&P 500 in four of the last five years and by a total of almost 50%, but you would never know it from listening to the ‘smart’ money at ideas dinners).
• Our bull case is that defense companies are morphing into technology companies that face limited global competition and enjoy scale advantages. They also screen well within our Rising ROE thesis. We have General Dynamics on the Focus List currently, but we also like Lockheed Martin and Raytheon.

Yaser’s Take–

• In 07, President Bush is looking to both reduce the federal budget and maintain the battle against global terrorism. As a result, the DoD budget is slated to grow at a slower rate than the past few years.
• According to DoD- "The Future Years Defense Plan for FY 07 through FY 11 projects growth from the $439 billion Department of Defense budget for FY 07 to $502 billion in FY 11."
• From what I’ve heard and read, these estimates do not include any estimates for ongoing military operations in Iraq & global war on terrorism, which are expected to be addressed through annual supplemental appropriations as required.
• In my opinion the best play continues to be LMT. LMT’s broad mix of programs & capabilities positions it favorably to support the future needs of the US government in both defense and information technology.
• LMT’s gross profit margin for the Q4 and entire 06 has significantly increased when compared to the same period a year ago. LMT has grown sales and net income during the past quarter when compared with the same Q a year ago.

Tomorrow we look at US financials, their exposure to international growth and more.

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