10 Key Issues Defense Stock Investors Need To Follow Over The Next 12 Months

• Large cap defense stocks outperformed the sector in 2015.
• Canaccord Genuity’s Ken Herbert mentioned 10 important issues and events that are likely to have a significant impact on the global A&D market and investor sentiment in 2016.

Analyst Ken Herbert cited ten important issues and events that could have a significant impact on the global A&D market and investor sentiment in the next 12 months. He stated that these are expected to “play a role in shaping investor sentiment and ultimately stock performance.”

1. Commercial book-to-bill important for sector sentiment
2. 787 execution and BA cash flow should be a positive catalyst
3. A350 ramp on schedule, but risk is to the downside
4. M&A – see a decline except for TDG and HEI
5. See better 2016 commercial AM performance, but airline efficiency the risk
6. Defense stocks in an election year – outperformance?
7. CSeries, MRJ, A320neo and other new entrants
8. Top 2016 stock picks based on company-specific commentaries
9. Restructuring to be an even more important theme in 2016
10. Passenger traffic and macro concerns

Herbert expressed optimism regarding the commercial OE cycle. He wrote, “We believe 2015 commercial transport orders of ~1,900, representing a book-to-bill of ~1.4x, are better than expected again.”

The analyst expects 2016 to be another year with a book-to-bill of more than 1.0x, which would be a positive. He added that several firms will benefit from strong OE growth next year, with deliveries growing by ~5 percent.

Defense stocks have outperformed the broader market by 17 percent in election years since 1992, Herbert pointed out. He expects Rockwell Collins, Inc. COL [Rated: Buy, PT: $105], Boeing Co BA [Rated: Buy, PT: $165], Esterline Technologies Corporation ESL [Rated: Buy, PT: $110] and Triumph Group Inc TGI [Rated: Hold, PT: $54] to benefit the most from positive defense sentiment.

“Granted, improved airline efficiency will continue to be a headwind, but we believe maintenance spending on older aircraft will increase, and 2016 expectations are very conservative,” the Canaccord Genuity noted. MSD AM growth could accelerate through the year in 2016. AM upside would mainly benefit TransDigm Group Incorporated TDG [Rated: Buy, PT: $260] and Heico Corp HEI [Rated: Buy, PT: $65].

Herbert named Spirit AeroSystems Holdings, Inc. SPR [Rated: Buy, PT: $70] as the top stock heading into 2016. He believes the company is best positioned to benefit from the strength in the commercial OE cycle and is significantly further along in its restructuring and cost efforts than many of its peers.

There is likely to be significant restructuring activity in 2016. Several firms like B/E Aerospace Inc BEAV [Rated: Buy, PT: $60], Rockwell Collins, Ducommun Incorporated DCO [Rated: Hold, PT: $27], Esterline Technologies and Triumph Group would be launching efforts or accelerating programs.

Although both B/E Aerospace and Esterline Technologies are now “show-me stories,” Herbert expects they both represent significant opportunity as management can deliver 1-2 quarters of in-line or ahead-of-plan results. “Both should also benefit from very conservative outlooks,” he added.