Should investors keep aerospace stocks on the radar screen?

Coming off several particularly brutal stock sessions, investors are still playing it as safe as possible, primarily favouring sectors with positive near-term prospects. One of those “chosen” sectors is aerospace.

Despite a tumultuous market environment and deteriorating commercial aerospace business fundamentals, the overall aerospace group, which includes manufacturers of aircraft and aircraft parts, still managed to outperform the broader market.

What has made the aerospace sector virtually immune to the current financial storm? In a word, war. Given the mounting prospect of war between the U.S. and Iraq, this group is climbing back above its July lows. This has translated in the following positive fundamentals:

• Highly favourable industry-wide outlook for the defense sector (with which the aerospace sector has a symbiotic relationship)
• Reasonable and, in some cases, deeply discounted aerospace stock valuations
• Comparatively sizable markets
• Relatively strong Q3 and Q4 earnings guidance (whereas many other sectors will likely struggle to post low single-digit top-/bottom-line growth)

Given these factors, the aerospace sector is poised to outperform the broader market for the remainder of the year (at the very least). Over the short to medium term, aerospace stock gains will likely come from companies with the following qualities:

• Little or no exposure to commercial aviation business (an area that must endure ongoing contraction)
• Relatively sizable markets
• Significantly discounted valuations
• Strong market share positions
• Experienced management teams

As the broader market gradually recovers, these companies will lead the sector, “firing on all cylinders.”

What’s the bottom line? In terms of total potential, the industry is undervalued and is “set to take off” over the next few months and years.

Some of the North American stocks that fall into this group include the following: AAR, Alliant Techsystems, Avcorp Industries, Boeing, Bombardier, Canadian Aerospace Group, Derlan Aerospace, DRS Technologies, Dunlop Standard, EDO, Engineered Support Systems, FLIR Systems, General Dynamics, L3, Lockheed Martin, Magellan Aerospace, Northrop Grumman, Precision Castparts, Raytheon, Rockwell Collins, Stewart & Stevenson, Titan, United Industrial and United Technologies.

September 2002