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- Aerospace stocks have taken a beating during the coronavirus crisis, but those with defence exposure now offer cheap opportunities, according to Morgan Stanley.
- The bank's equity analysts said in a note that concerns about these companies' budgets are "overtorqued".
- Here are the four stocks that are likely to benefit from increased defence spending, according to Morgan Stanley
- Visit Business Insider's 合约数字币和虚拟币homepage for more stories.
Aerospace stocks have been some of the worst hit by the coronavirus pandemic, which brought air travel to a standstill earlier this year and even though there has been a pick-up, it's a long way off where it was a year ago.
The shunning of this sector has been exacerbated by a growing preference among investors for more environmentally and socially responsible sectors, as well as the massive headwinds a lot of aerospace companies face with governments pouring money into fighting the pandemic, rather than other causes, such as defence spending.
However, not all aerospace stocks are unpopular right now. Those with defence exposure offer a good opportunity at cheap prices, according to Morgan Stanley.
Some stocks, which were already undervalued by the market, have been weighed down further by worry over government budget cuts for defence contracts. However, this concern is "overtorqued," according to a Morgan Stanley note ed by equity analysts Andrew Humphrey and Joseph Ayoola.
"While higher government deficits (and absolute debt levels) create a degree of concern on budgets, we see several supportive factors," they said, listing the following:
- "Exposure among the group skews towards strategic capability development, recapitalisation and near-peer threats," they said
- "There is less scope for budget reductions through drawdown of deployed forces than was the case during the previous cycle"
- "We do not perceive as much of an austerity agenda in government policy in key markets as we did post-GFC"
- "We see upward pressure on NATO spending, regardless of political outcomes. The recently announced 4-year settlement for UK MoD underscores resilient fundamentals for BAE Systems in particular," they said.
Moreover, the short-term underperformance of the sector has "coincided with a period of very high correlation with value factors," the note said. But, this performance is anomalous, and therefore likely to unwind, they added.
This is because the "recent high levels of correlation have not been as high in previous periods, and... we think there is scope for settlements on US and UK defence spending in 2021 to act as catalysts for a reappraisal," the note said.
These are Morgan Stanley's four picks from the aerospace sector that have plenty of scope to rally from here:
- Ticker: BAES.LDN
- Upside: 19.68%
- Market cap: £16.96 bln
- Price target: 630p
"We derive our price target of 630p by applying a 10.5x EV/EBIT multiple on 2021e adjusted EBIT of €2.3bn. We view this as a reasonable multiple for a stock with stable to improving spending from government customers, a low cost of capital, and single-digit earnings growth with good visibility for the next several years," the note said.
- Reasons for the overweight rating:
- BAE has a defensive earnings profile: "We view the earnings profile as highly defensive, with >90% of sales in defence end markets. Visibility is underpinned by gains on US land programmes, and a record order backlog," the note said.
- Its mid-term EPS growth path remains on track: "We expect a modest decline in 2020 EPS, largely reflecting temporary disruptions. We forecast an EPS CAGR of 5% over 2019-2022 as this normalises" it added.
- Positive strategic developments may yield rating upside over time: "Recent acquisitions increase exposure to high-growth areas of the US budget, whilst funding actions have de-risked pension liabilities in our view. Over time, we believe this may support a narrowing of the discount to US peers," it concluded.
Dassault Aviation SA
- Ticker: AVMD.PA
- Upside: 23.32%
- Market cap: $9.25 bln
- Price target: €1,115.00
"Our €1,115 price target is derived from a 6x EV/EBIT target multiple on average 2020-22 core business EBIT. Whilst this represents a discount to European defence peers, we view this as warranted given lower relative visibility in the core business and higher platform concentration," the note said, adding that Morgan Stanley "value the 25% Thales stake at market value, and also factor €2.2bn of customer prepayments unwind over the medium term as a debt item in our valuation."
- Reasons for overweight thesis:
- "The valuation of Dassault Aviation is tripartite - cash in the business, a 25% stake in Thales and two strong franchises in business jets (Falcon) and fighter jets (Rafale)."
- "The recent decline in the share price - in line with the broader sector - now implies a minimal valuation for the core business in our view."
- "Dassault Aviation is the OEM for the Rafale fighter jet and the Falcon. There is optionality on both platforms over the next several years with a large potential Rafale order for India, and the launch of the Falcon 6X, with deliveries starting in 2022."
- "Our base case factors in a €2.2bn unwind of advance payments and takes into account the market value of the Thales stake."
- Ticker: LDOF.MI
- Improvements in fundamentals delayed; leverage rising
- Upside: 25.42%
- Market cap: $4.06 bln
- Price target: €7.40
"We derive our price target of €7.40 by applying a 7.0x EV/EBIT multiple on 2021e adjusted EBITA of €1.0bn. This is a 20-30% discount to the main peers and broadly in the lower range of its 3-4 year average of 7-8x. Higher financial leverage means the equity is sensitive even to a modest re-rating," the note said.
- Reasons for equal-weight thesis:
"We believe headwinds are likely to persist in Leonardo's civil end markets - particularly in helicopters, aerostructures and the ATR joint venture."
"Previous progress on improving execution and cash generation within the business is likely to be delayed, we think, limiting the scope for a re-rating."
"We continue to see significant potential for longer-term upside, though higher operational and financial leverage than peers means there is potential for volatility. ▪ Our €7.41 PT is based on an EV/EBIT multiple of 7.0x on 2021e earnings, a 20- 30% discount to the main peers and broadly in the lower range of its 3-4 year average of 7-8x."
- Ticker: RHMG.DE
- Upside: 33.64%
- Market cap: $4.01 bln
- Price target: €104.00
- Reasons for overweight these:
"Defence tailwinds to continue. We model a 7% 5-year revenue CAGR in defence, driven by high exposure to German budget growth and gearing into European land spending tailwinds."
"2020 contract wins can drive defence re- rating. We see significant mid-term optionality in the Lynx programme. We think positive news flow on >€10bn of contract opportunities in 2020-21 can highlight long- term growth prospects, and catalyse a re- rating."
"Automotive forecasts re-based, peer valuation supportive. We assume only partial demand catch-up, and forecast c4.5% margin in auto in 2021 (vs 6-8% mid-cycle margins). We value the business at a discount to peer sales multiples, with an EV equivalent to €30/share."