(By Mani) US aerospace and defense companies are scheduled to release calendar first quarter results over the next 3-4 weeks, with large caps including Honeywell International, Inc. (NYSE:HON), Boeing, Inc. (NYSE:BA), General Dynamics Corp. (NYSE:GD), Raytheon, Inc. (NYSE:RTN) and Lockheed Martin (NYSE:LMT) expected to report next week.
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The aerospace sector witnessed continued OEM-led growth this quarter, which in turn should drive operating leverage. Aftermarket growth could start the year a little sluggish, given tough comps versus last year and some weakness in fourth quarter traffic growth. Meanwhile, the sector could deliver improved margins given increasing volumes and good cost controls.
"We expect 1Q12 results to support our overweight stance on aerospace, and market weight view on defense. We see aerospace as largely an earnings story, as the up-cycle revenue outlook is well appreciated, whilst the sector trades at an appropriate average of 13.2x 2013 P/E," RBC Capital Markets analyst Robert Stallard wrote in a note to clients.
Investors will look to see how defense contractors perform this quarter amid a mixed defense budget. This is an area where some of the largest revenue pressures are expected, particularly in the overseas contingency operations (OCO) arenaand operating margin pressure thanks to intense competition.
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The Obama Administration recently released the fiscal 2013 department of defense (DoD) budget of $613.9 billion, a 5 percent drop from the 2012 budget. The base budget also declined about 1 percent to $525.4 billion, and the majority of the cuts came from the Overseas Contingency Operation budget.
In most cases, defense contractors were on both sides, with some positives and some negatives. Many of the cuts, delays, and terminations were opportunistic, with lower quantities needed due to declining out-year troop levels. Of the $45 billion in savings in 2013, about $24 billion or 53 percent of cuts came from the Investment Accounts.
"This could place downward pressure on defense estimates, as managements may have underestimated how difficult things could be. Overall, we see the continuation of the pattern seen in defense through 2011 - weak revenues, steady margins and share buybacks combining to produce in line EPS," Stallard added.
As original equipment and aftermarket volumes grow, the analyst sees the potential for better than expected margins, and accretive cash deployment.