Strong Investment in 2017 With More to Come in 2018

February 08, 2018

While the media continued to perform in a three-ring circus in 2017, the U.S. stock market, and the aerospace and defense (A&D) sector in particular, posted tremendous gains for the year. All of our A&D indices beat the S&P (+19%), led by our Aircraft Structures & Support index (+49%) and our Military/Defense index (+29%). It was a great year to invest in the sector! M&A activity remained strong, and valuation multiples continued to expand. The anticipation and passage of the corporate tax overhaul signed into law in December was clearly the dominant factor driving the market, while sector-specific factors pushed up both defense and commercial sectors.

Gains in the defense sector continued, though since 2007, spending in the sector has significantly lagged entitlement spending (Social Security, Medicare, Medicaid, etc.). As shown in the chart below, entitlements now represent two-thirds of all federal spending, while defense has shrunk to 15%. In light of these statistics it is difficult to contest the assertion that U.S. military power and readiness has diminished.

percent federal outlays chart 1

Defense

The good news is the 2018 Defense Budget Request for U.S. military spending is larger than the next nine countries combined, and the base budget request represents an almost $60 billion increase over 2017 spending.

President Trump signed the 2018 National Defense Authorization Act on December 17 with a target spending of about 10% more than the caps established in the 2011 Budget Control Act.  Sequestration was avoided when Congress passed a two-year budget deal on February 9, increasing defense spending by $80 billion in each of fiscal years 2018 and 2019. The allocation of the additional spending is yet to be determined, but guidance can be seen from the budget request details below.

Changing priorities reflect perceived increased risk of China’s rapidly expanding military, an increasingly aggressive Russia, and growing nuclear risks in North Korea and Iran, as these priorities have outpaced judged risks related to ISIS.

2017 Major Weapons Programs 

 

Commercial

Boeing ranked as the top-performing stock in the Dow Jones Industrial Average for 2017 with its share price up more than 90%. It plans to increase 737 production from 47 per month to 52 per month in 2018 and 57 per month in 2019. Production of the 787 is scheduled to rise from 12 per month to 14 per month in 2019.

Airbus orders were significantly better than expected, and production was up for the 15th consecutive year. With production of the A380 at risk of shutting down, the program was rescued on January 18, 2018, with an order of 36 new planes by Emirates. This represented the first new order in almost two years.

The challenges of competing with these two behemoths is demonstrated by Bombardier’s sale of a 50.01% majority interest in its C-Series single-aisle passenger jet program to Airbus for no cash consideration, along with Bombardier’s pledge to fund the business with up to an incremental $700 million over three years. This, of course, is after the Quebec government bailed Bombardier out in 2016 with a $1 billion investment for 49.5% of the C-Series program. The proposal to move production to Airbus’ Alabama plant may help the program avoid proposed 300% anti-dumping and anti-subsidy duties.

Meanwhile, Boeing has engaged in discussions to acquire the Brazilian jet maker Embraer. The deal requires the approval of the Brazilian government and would further consolidate the industry. Just as with the addition of the C-Series jets to the Airbus lineup, the combination of the Embraer E-jet line at the low end of Boeing’s product offerings will add to the latter firm’s competiveness against Chinese and Russian manufacturers attempting to encroach on its markets.

 2017 Boeing

2017 Airbus

Rotorcraft

Weak oil prices continue to plague the civilian commercial market for helicopters, but the consensus is that this market has stabilized at a relatively low level. By gaining market share, Airbus has maintained revenues and has become the dominant player in the civil market with 260 rotorcraft delivered for the civil sector, representing an estimated 50% share of deliveries for helicopters with more than five seats. Robinson Helicopter continues to dominate the small helicopter market with its total deliveries since inception eclipsing 12,000 aircraft.

U.S. military rotorcraft procurement is dependent on funding. Specific helicopters requested are shown in the weapons programs table above.

M&A Outlook for 2018

In the middle market, sellers continue to be motivated by robust valuations being offered by acquirers. Public buyers in the sector are buoyed by robust stock prices and board directives to drive growth through acquisition, as organic growth is much more difficult to sustain. Sponsors are working hard acquire new platforms in an intensely competitive sellers market. Driving multiple expansion through add-on acquisitions is a tried-and true-strategy for strong returns among private equity sponsors with existing platforms. With all of these factors continuing, the outlook for robust M&A activity in 2018 is strong.

Volume and Valuation Trends

  • While transaction volume has begun to flatten and marginally decline, valuations have seen impressive growth as 2017 was a record year for deal value
  • M&A transaction volume decreased 1% to 288 transactions, and median valuation multiples increased over 20%, to 13.3x EBITDA in 2017.
  • Commercial aerospace has faced significant competition, ultimately triggering consolidation. Meanwhile, Trump’s emphasis on the defense budget has resulted in growth of the industry and further investment in related technologies

ma volume and valuations chart 5

Sector Trends

  • The strongest sectors of A&D M&A growth last year occurred within the machined parts & components sector.
  • Electronics, IT, & Communication Systems maintained its position as a a leading M&A sector as new satellite technologies directly support both aerospace and defense industries
  • Stable demand continues to exist for Military & Defense, Machined Parts & Components, and Engineering & IT consulting services

ma volume by sector chart 6

Buyer/Seller Trends

  • Both strategic and financial buyers were active in A&D transactions in 2017. There was a noticeable increase in transactions coming from hybrid buyers, likely receiving encouragement from their financial owners to cash out at larger deal values and multiples
  • The majority of sellers continue to be owners of privately held companies. Publicly traded and private equity sellers represented a relatively small share of transaction volume.
  • M&A activity continues to be supported by ongoing consolidation in the public-companies sector, a favorable lending environment, and increasingly competitive demand from financial buyers.

2017 ma activity by buyer seller type chart 7

2017 Stout Scorecard

stout aerospace defense scorecard chart 8

2017 market performance chart 9

2017 valuation trends - ev ntm ebitda chart 10

Aircraft, Structures & Support: Airbus Group SE (AIR), The Boeing Company (BA), Bombardier Inc. (BBD.B), CAE Inc. (CAE), Embraer S.A. (EMBR3), HEICO Corporation (HEI), Honeywell International Inc. (HON), Kaman Corporation (KAMN), Latecoere S.A. (LAT), LMI Aerospace, Inc (LMIA), Spirit AeroSystems Holdings, Inc. (SPR), Textron Inc. (TXT), Triumph Group, Inc. (TGI).

Mechanical, Propulsion & Landing: AAR Corp. (AIR), Curtiss-Wright Corporation (CW), Heroux-Devtek Inc. (HRX), Meggitt PLC (MGGT), Moog Inc. (MOG.A), Rolls-Royce Holdings plc (RR.), Safran SA (SAF), Senior plc (SNR), TransDigm Group Incorporated (TDG).

Electronics, Avionics & Interior: AMETEK, Inc. (AME), Astronics Corporation (ATRO), B/E Aerospace, Inc. (BEAV), Cobham plc (COB), Dassault Systèmes SE (DSY), Ducommun Incorporated (DCO), Esterline Technologies Corporation (ESL), Rockwell Collins, Inc. (COL), Teledyne Technologies Incorporated (TDY), Thales SA (HO), Ultra Electronics Holdings plc (ULE), Zodiac Aerospace (ZC).

Military & Defense: BAE Systems plc (BA.), Chemring Group plc (CHG), General Dynamics Corporation (GD), L3 Technologies, Inc. (LLL), Leonardo S.p.a. (LDO), Lockheed Martin Corporation (LMT), Northrop Grumman Corporation (NOC), Orbital ATK, Inc. (OA), Raytheon Company (RTN), SAAB AB (publ.) (SAAB B).

 

Notable 2017 M&A Transactions

Notable Transactions - Sorted Announcement Date

Notable Transactions - Sorted Enterprise Value

Orders, Deliveries & Backlogs

Boeing and Airbus Deliveries, Orders, and Backlogs

  • 2017 was another solid year for commercial aerospace, with Boeing and Airbus achieving airframe deliveries of 763 and 718, respectively.
  • Likewise, with commercial aircraft backlogs increasing to new all-time highs (combined Boeing and Airbus backlogs rose by more than 500 aircraft in 2017) and strong industry fundamentals (such as global travel demand, airline profitability, availability of aircraft financing, and aging airline fleets), we believe the commercial aerospace industry is poised for continued growth in 2018.
  • Recent oil price increases have pushed jet fuel prices to their highest level since 2014, which has increased the push for accelerated aircraft retirement. However, it’s unclear whether major players are betting with the assumption that the current spot price will be the new norm going forward.
  • Overall, we are optimistic that all segments of the commercial aerospace supply chain will continue their upward trend in 2018 as they did in 2017 – and we expect M&A activity and valuations to remain strong.

single aisle deliveries chart 11

1. Deliveries for the following aircraft families: Boeing 717, 737, 757; McDonnell Douglas MD-80, MD-90; Airbus A320

twin aisle deliveries chart 12

2. Deliveries for the following aircraft families: Boeing 747, 767, 777, 787; McDonnell Douglas MD-11; Airbus A330, A340, A350, A380

2017 boeing and airbus backlogs chart 13

 

Publicly Traded Companies

Enterprise Value LTM EBITDA Multiples

Enterprise Value NTM EBITDA Multiples

Aircraft, Structures & Support: Airbus Group SE (AIR), The Boeing Company (BA), Bombardier Inc. (BBD.B), CAE Inc. (CAE), Embraer S.A. (EMBR3), HEICO Corporation (HEI), Honeywell International Inc. (HON), Kaman Corporation (KAMN), Latecoere S.A. (LAT), Spirit AeroSystems Holdings, Inc. (SPR), Textron Inc. (TXT), Triumph Group, Inc. (TGI).

Mechanical, Propulsion & Landing: AAR Corp. (AIR), Curtiss-Wright Corporation (CW), Heroux-Devtek Inc. (HRX), Meggitt PLC (MGGT), Moog Inc. (MOG.A), Rolls-Royce Holdings plc (RR.), Safran SA (SAF), Senior plc (SNR), TransDigm Group Incorporated (TDG).

Electronics, Avionics & Interior: AMETEK, Inc. (AME), Astronics Corporation (ATRO), Cobham plc (COB), Dassault Systemes SE (DSY), Ducommun Incorporated (DCO), Esterline Technologies Corporation (ESL), Rockwell Collins, Inc. (COL), Teledyne Technologies Incorporated (TDY), Thales SA (HO), Ultra Electronics Holdings plc (ULE), Zodiac Aerospace (ZC).

Military & Defense: BAE Systems plc (BA.), Chemring Group plc (CHG), General Dynamics Corporation (GD), L3 Technologies, Inc. (LLL), Leonardo S.p.a. (LDO), Lockheed Martin Corporation (LMT), Northrop Grumman Corporation (NOC), Orbital ATK, Inc. (OA), Raytheon Company (RTN), SAAB AB (publ.) (SAAB B).

 

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