Recently, we painted a somewhat bleak future for the Aerospace / Defense Industry. Our analysis revealed that the industry was undervalued by nearly 10% as a whole. Given the numerous possibilities for revenue and profit contraction, there are a few stocks worth further research.
Currently, Hawk Corporation and DRS Technologies, Inc. offer investors a compelling margin of safety. DRS Technologies, Inc. is both a value and growth opportunity. The company's well diversified product portfolio suggests the stock is undervalued. This also should provide a strong growth opportunity.
Table 1: Aerospace / Defense Industry Summary
Our previous industry analysis yielded these 10 candidates for investment. Further scrutiny shows that Hawk and DRS offer investors the most significant margin of safety. DRS Technologies is especially well positioned to offer investors compelling returns. The corporation’s revenue and profit streams are well diversified so that no program accounts for more than 10% of revenue. Their top ten programs total less than 25% of total revenues. The next chart represents a filtered universe of aerospace / defense stocks
Table 2: Aerospace / Defense Stock Universe
Our initial test shows that Aerospace / Defense contains numerous investment opportunities. The most attractive companies are well diversified with contracts from each branch of the military. The most attractive of the lot, DRS Technologies (DRS), is a well diversified defense contractor who provides surface, naval, and aerospace solutions to the U.S. military. Since they serve multiple branches of the military, their revenue streams and potential growth seems quite strong.
Table 3 shows calculated take out / private equity values for the most attractive Aerospace / Defense stocks. This value is the crux of our valuation analysis. Take out value is quite pertinent to the Aerospace / Defense industry due to its cyclical nature. The winds of change constantly blow and change direction depending upon whether Democrats or Republicans control the Federal Government. Recently, a high level Aerospace / Defense executive stated that investment bankers expect that all companies in this industry under $1B in market cap to be private in the next five years.
Table 3: Take Out / Private Equity Values for Selected Aerospace / Defense Stocks
Each of the selected stocks trades at a substantial discount to its relative take out value. Smaller companies will benefit most from private equity investment. These values are moot points for companies such as General Dynamics and Lockheed Martin because they are so large. Companies such as Kaman and Hawk can benefit from private equity by spinning off some of their extraneous lines of business. DRS Technologies provides the most compelling private equity story. This company has an attractive portfolio of defense contracts ranging from tanks to ships to aircraft. Such an attractive portfolio could be of great value to larger contractors or private investors.
Table 4: Relative Analysis of Selected Aerospace / Defense Stocks
On a relative basis our selected stocks put up a strong showing. Again each company offers a substantial margin of safety when comparing relative value to the current price. The most compelling opportunities are: Ducommun, Inc.; DRS Technologies, Inc.; Hawk Corporation, Inc.; and, Kaman Corp. The latter two, Hawk and Kaman, probably are discounted due to their unique lines of business. Ducommun and DRS both have a well diversified portfolio of defense contracts. The relative valuations substantiate the take out values calculated for these companies.
Table 5: Earnings Power Value Compared to Reproduction Value
Value investors like to compare the growth / earnings component of a specific business to the amount it costs to reproduce or start that business from scratch. Table 5 shows these values for our selected Aerospace / Defense stocks. Only DRS Technologies and Lockheed Martin offer a margin between EPV and Reproduction value. Therefore, it can be reasonably deduced that these two businesses are at a minimum worth their reproduction value, and on the high end, worth their earnings power value.
Table 6: WACC Calculations for Selected Aerospace / Defense Stocks
Readers can see that Aerospace / Defense offers some interesting and compelling investment opportunities. The above analysis suggests that DRS Technologies, Inc. (DRS) offers the best value to investors. DRS’s well diversified product portfolio makes it an attractive target to private equity and aerospace / defense contractors.
Coming up:
DRS Technologies, Inc. (DRS)
ConocoPhillips (COP)
Major Integrated Oil and Gas
Medical Labs and Research
Scientific and Technical Instruments
Semiconductor Equipment and Material
