For defense contractors, ‘sequestration’ has been anything but a disaster.
U.S. defense budget cuts haven’t had the catastrophic impact on aerospace and defense companies as some expected. In fact, companies such as Boeing are flying high on robust commercial airline orders both at home and abroad at a time of recovery for global economies, and are taking related ETFs along for the flight higher as well.
The U.S. Budget Control Act of 2011 set discretionary spending caps and created a process that resulted in automatic cuts—dubbed sequestration, that began in March—and will cut $1.2 trillion in defense and nondefense spending over nine years.
But sequestration hasn’t had a negative impact on returns for the aerospace and defense sector. In fact, the S&P 500 Aerospace & Defense Index is up 43.33 percent year-to-date, easily outperforming the S&P 500’s tally of 24.84 percent YTD.
The positive drivers spurring the commercial aerospace sector include a recovering global economy, improving profitability for airlines and record robust orders, according to Eric Hugel, an equity research analyst at S&P Capital IQ.
“There’s been very strong demand from carriers for new aircraft to replace older fleets and also to grow in emerging and developing markets,” Hugel said in an interview.
Related ETFs such as the iShares U.S. Aerospace & Defense ETF (ITA | B-78), the PowerShares Aerospace & Defense Portfolio (PPA | B-73) and the SPDR S&P Aerospace & Defense ETF (XAR | B-72) are trouncing broader markets.
Year-to-date, ITA, PPA and XAR are up 59.8 percent, 52.3 percent and 55.8 percent, respectively.
Chart courtesy of StockCharts.com
The first round of defense cuts under sequestration reduced $37 billion from the Pentagon’s budget, reportedly forcing civilian furloughs, canceling training operations and ship deployments, and deferring maintenance.
However, Hugel noted many expectations of budgetary catastrophe were averted because of how the Department of Defense was able to move money around and use unspent money to fill in holes across several programs.
“And while sales have been down, management has been able to cut costs and improve efficiency to offset a lot of that. At the same time, these companies are still generating a significant amount of free cash flow, and they’re using that cash flow to raise dividends—which investors like—pay down debt and, very importantly, buy back stock,” said Hugel.
Key names in ETF portfolios such as Alliant Techsystems, a supplier of aerospace and defense products to the U.S. government, are reporting strong sales in other parts of their businesses not related to military contracts.
Alliant Tech last week reported second-quarter year-over-year sales were up 7 percent to $1.1 billion due to increased sales in its Sporting group, which includes shooting sports and outdoor markets, partially offset by a sales decline in its Defense group.
Boeing reported a revenue increase of 11 percent to $22.1 billion, reflecting higher commercial deliveries. The company’s commercial airplanes unit reported that third-quarter revenues increased to $14 billion on the strength of strong demand for its 787 family of airplanes. In fact, the unit intends to increase the 787 production rate from 10 to 12 per month in 2016.
Boeing’s presence at the 2013 Dubai Airshow next week will also highlight a broad lineup of defense and commercial products and services that it intends to roll out to meet the needs of its Middle East customers.
Honeywell, a commercial and defense technology company, reported an 11 percent drop in defense and space sales as a result of planned ramp-downs and program delays, partially offset by growth in its commercial unit, which recorded a sales increase of 3 percent.
However, the company is forecasting up to 9,250 new business jet deliveries worth more than $250 billion from 2013 to 2022. The company is also projecting 2013 deliveries of approximately 600 to 625 new business jets, a single-digit decrease over levels reported last year due to new-order delays rather than lack of demand.