To say that the election of Donald Trump as president was bullish for the aerospace and defense sector would be a massive understatement. With shares up over 90%, Boeing Co. (NYSE: BA) was the top-performing stock in the venerable Dow Jones Industrial Average. While that kind of massive outperformance is probably not in the cards for 2018, it remains a solid bet that the sector will see additional gains.
One of the keys for this year is going to be stock selection, and in a new research report from SunTrust, while they remain positive overall, caution seems to be one of the important aspects for this year. The report stated why:
We remain somewhat sensitive to valuations while paying close attention to company specific fundamentals, but in total, we anticipate that the A&D sector will again outperform the S&P 500 in 2018. Reduced tax rates should drive upward estimate and price target revisions with the added benefit of fueling shareholder friendly capital deployment initiatives.
The SunTrust analysts have three favorite aerospace and defense ideas for 2018, and all make sense for long-term growth portfolios with a degree of risk tolerance. They noted this when discussing the top picks:
2017 will be a tough act to follow and while a still rising tide may lift all boats, we believe stock selection will be critical to generating alpha over the next 12 months. Out of favor performance and valuation laggards will likely be a common strategy that we largely agree with. Staying the course with best-of-breed, top quality companies, also fits our criteria.
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FLIR Systems
This stock offers excellent upside potential and a more moderate valuation. FLIR Systems Inc. (NASDAQ: FLIR) designs, develops, markets and distributes thermal imaging systems, visible-light imaging systems, locater systems, measurement and diagnostic systems and threat-detection solutions. The company’s segments include Surveillance, Instruments, Security, OEM & Emerging Markets, Maritime and Detection.
The Instruments segment provides devices that image, measure and assess thermal energy, gases and other environmental elements for industrial, commercial and scientific applications under the FLIR and Extech brands. The OEM & Emerging Markets segment provides thermal imaging camera cores and components. The Maritime segment develops and manufactures electronics and imaging instruments, and the Security segment develops and manufactures a range of cameras and video recording systems.
The analysts said this:
We upgrade FLIR Systems to a BUY as we have become more constructive post management changes on the company’s government prospects, its ability to improve operating metrics, and potential value creation opportunities through divesting non-core product lines.
The SunTrust price target for the shares is $55, and the Wall Street consensus figure is $49.22. Shares closed Monday at $49.67.
L3 Communications
Many analysts like this company into its fourth-quarter earnings, which are expected the week of January 26. L3 Communications Holdings Inc. (NYSE: LLL) provides aerospace systems and a range of communication and electronic systems and products used on military and commercial platforms in the United States and internationally.
The company operates in three segments: Electronic Systems, Aerospace Systems and Communication Systems. It offers a range of products and services, including components, products, subsystems and systems, as well as related services to military and commercial customers in business areas, including precision engagement and training, power and propulsion systems, aviation products and security systems, sensor systems, warrior systems, and optics, telescopes and precision optical subsystems.
L3 Technologies produces electro-mechanical and mechanical fuzes to support missiles and artillery systems that enable for high-speed and high-accuracy sensors. Raytheon’s AIM-9X Sidewinder missiles bolster L3’s fuzing capabilities. It is expected to see some ancillary revenue from the huge Saudi deal signed last year.
The analysts are positive on multiple catalysts:
Not only should L3 benefit from increasing defense spending, but we believe the added benefit of operational improvement efforts will help to drive disproportionate margin expansion compared to its peers.
SunTrust has a $232 price objective, while the consensus target is $220.93. Shares closed Monday at $203.26.
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Transdigm
This stock had a very volatile 2017 and is the favorite valuation play at SunTrust. Transdigm Group Inc. (NYSE: TDG) is a holding company for different businesses that provide a diverse array of products, including ignition systems, pumps, valves, motors, actuators, controls, water faucets and systems, quick disconnects and couplings, batteries, chargers and power conditioning, cockpit security systems, composites and elastomers, audio systems, and lighting and displays.
The company has a unique position among the defense companies as 90% of sales are proprietary, 75% are sole-sourced and 54% are aftermarket-related. The SunTrust report noted this:
Transdigm is our preferred aftermarket exposed name, and also comes with plenty of controversy that has created a discounted valuation versus its historical multiple and the peer group. We believe the company will face easier first half 2018 comparisons that should help the stock work.
The $307 SunTrust price target compares with the consensus target of $298.44. The stock closed Monday at $276.02.
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Three top companies that could ramp up earnings big time if the tax plan in its current form proves to indeed act as a tailwind. Plus, given the volatile situations around the globe, and continued big foreign purchasing, the sector remains a good place to keep capital in growth portfolios.
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