Northrop Grumman Corporation (NOC), The Boeing Company (BA), Sequestration: Is it a Valid Reason to Short the Aerospace industry?

Then what?

Boeing is expected to reiterate its 2013 EPS guidance, given it is early in the year. Moreover, the 787 issue has been settled, and hence no changes will be made to the 787 delivery schedule. Though, it is interesting to note that a change in the 787 schedule would have hardly caused any change to the EPS given the low profit margin of the program.

Focus items

2013 new aircraft order expectations

Sequestration and the Defense budget

Cash flow generation and capital deployment

Next-generation aircraft product strategy

So are we convinced that sequestration matters?

Just to check whether budget cuts have really dented the outlook of aerospace stocks with exposure to defense spending, I chose to preview the earnings of B/E Aerospace Inc (NASDAQ:BEAV), a pure-play on commercial aircraft demand. And guess what? The market is right. Budget cuts have definitely been the main culprit behind low year-to-date gains on these stocks.

B/E Aerospace Inc (NASDAQ:BEAV) is currently on Goldman’s conviction buy list. The company is expected to beat the earnings estimate on the back of higher than expected Inter-turbine revenue. Its Commercial Aircraft and Business Jet businesses are expected to grow by mid-to-high single digit figures for the year. The book-to-bill is expected to remain greater than 1.0x for 2013.

There is some room for the guidance to be revised upwards, but BA Aero doesn’t normally do so at the start of the year. Still, the company is expected to provide an upbeat update on its outlook for 2013 orders, new Aerospace supplier furnished equipment (SFE) wins (both OE and retrofit), general aftermarket trends, and capital deployment opportunities. The company will likely provide a recap of the Hamburg Aircraft Interiors Show, including overall order strength and SFE opportunities.

Focus items

Aftermarket trends

Airline ordering patterns

SFE production ramp

Capital deployment priorities

Final word

Defense budget cuts have definitely had a far-reaching impact on stocks with defense exposure. Moreover, this season’s earning calls will provide more color on further probable cuts. However, to say that every stock with an exposure to defense spending is a sell would be totally unjustified. Every company has its own story, and nothing can be decided before carefully analyzing whether growth in a company’s other segments can help to offset declining defense revenues.

The article Sequestration: Is it a Valid Reason to Short the Aerospace industry? originally appeared on Fool.com and is written by Masam Abbas.

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