RTX - Top Aerospace And Defense Stocks For 2024: Uncovering Gems In A Crowded Sector

2023-12-29 13:12:42 ET

Summary

• 2024 will be an interesting year for aerospace and defense stocks. We select three buy opportunities with price targets.
• Picking aerospace and defense stocks can be challenging due to the long-term nature of the industry.
• Investors should consider a mix of defense and commercial stocks, with commercial airplane manufacturing offering growth opportunities.
• Boeing and Airbus stocks have performed well in 2023, exceeding expectations with gains of more than 30%.

With the year coming to an end, it's also time to consider in what directions, we will be looking for value for next year. I generally believe that the aerospace and defense industry offers compelling investment opportunities but there are also plenty of side notes to be made. In this report, I will be highlighting three investment opportunities and discuss some things to keep in mind when investing in the aerospace and defense industry in 2024. Before I do so, I will discuss how our 2023 Investing Group Roundtable buy calls performed as well our overall portfolio of aerospace buy calls, because I think it's very important to revisit ratings.

Previous Buy Calls Have More Than Delivered

In a report published January 2023, I marked Boeing (BA) and Airbus (EADSF) as a buy with expected conservative returns in the 25% to 30% range but with lingering supply chain issues pushing airplane values higher. And that has indeed be the case. Year to date, Boeing stock has gained more than 33%, exceeding expectations and Airbus stock returned nearly 30%.

So, the buy calls worked out extremely well, and overall our aerospace buy calls which we give a one-year incubation period to keep in mind the long-term nature of the industry has shown strong outperformance. And that has not been a matter of throwing darts of a stock list to select stocks as is evident by the fact that on a flat market our aerospace picks returned nearly 40% surpassing the Aerospace ETF (ITA) performance as well.

Why Picking Aerospace and Defense Stocks Can Be Challenging?

When it comes to aerospace and defense stocks picking the right ones is an art itself. The industry tends to be very long-term focused with production lives that can last decades plus decades of servicing delivered products and in those decades a lot can happen as we some with the events since 2020. I wouldn't say it makes picking stocks each year useless. But I would point out the long-term nature of the business which might in some cases result in unfavorable results on a one-year basis but show exceptional performance compared to the broader markets on multi-year timeframes.

What also is important to keep in mind is that aerospace and defense can roughly be divided in defense and commercial and having a healthy mix might be beneficial. Defense is currently considered a growth opportunity and generally I would agree, but we're also seeing that getting defense aid packages approved has become more challenging in the US which might provide another sentiment damper on defense stocks as has been the case the past year. So, the defense budgets are expanding but sentiment might rule in 2024. For commercial, things are looking quite a lot better as we see demand still outpacing the ability of commercial jet makers to deliver airplanes which feathers positively into pricing power. In 2024, despite the cumbersome state of the Eurozone, I do expect continued strong demand for commercial airplanes and supply chain pressures which have ticked up in recent months to continue being present. Nevertheless, we should see some growth in output on the commercial ends as the supply chain health is slowly but surely improving.

Go Defensive Or Aim For Growth In 2024?

Keeping the challenges in mind, investors have to decide whether they want to go on the defensive mode with defense stocks and lean on stock buy backs and dividend increases as we usually see with companies such as Lockheed Martin ( LMT ) and Northrop Grumman ( NOC ), among others, or add exposure to commercial airplane manufacturing, and I would be inclined to say that the latter offers quite some opportunities. Last year, Boeing ( BA ) made it to my list but that's not the case this year as the company has a valuation that's grown a bit ahead of its valuation.

Top Aerospace and Defense Stock Pick No. 1 - Spirit AeroSystems

Spirit AeroSystems had a year that can best described as awful with disappointing performance on the Boeing 737 program where it in fact was the bottleneck due to quality issues resulting in Boeing lowering its delivery guidance for the year. And on other single programs such as the Airbus A220 and Airbus A320 things weren't rosy either due to financial issues at a supplier for the A220 program and Airbus lowering shipset orders for the year. It left the company to lean on its aftermarket business as next generation wide body programs also are loss making. Legacy wide body programs are not high volume and defense programs are also in a challenging state.

However, I do view the appointment of Patrick Shanahan as CEO of Spirit AeroSystems as a positive pivot. Since Shanahan's appointment as CEO the company reached a tentative agreement with its major customer Boeing to get a better pricing in the near term while the company also is looking to better streamline its debt maturity profile and receive better contract terms with Airbus.

Calculated using the evoX Stock Screener, I have a buy rating on Spirit AeroSystems stock with a $39.40 price target noting that positive momentum in the industry and Spirit's execution path could push the stock over $40 on multiple expansion. Spirit AeroSystems is ranked seventh in the list of Top Aerospace and Defense Stocks with Buy rating from SA Quant , a Hold Rating from SA Analysts and a Buy rating from Wall Street Analysts with an average price target of $31 and a higher target of $45.

Top Aerospace and Defense Stock Pick No. 2 - Bombardier

Bombardier has been executing a remarkable turnaround as is evident by its stock price return since my Buy rating in 2022. However, the stock price has been flattish in 2023 even though the company is successfully deleveraging its balance sheet, increases production in a healthy demand environment and is expanding in the areas of aftermarket sales and refurbishing used jets all of which will add value to the Bombardier product making it even more desired while also exploring a more prominent role in defense solutions.

For Bombardier stock, I have a Strong Buy rating with a $62.20 Buy rating representing 55% upside to the stock price and I believe that after a year where the stock price was flat and fundamentals and execution continued to improve having significant upside potential makes a lot of sense. Bombardier does not have a favorable score ranking 40th in the list of Top Aerospace and Defense stocks/ The company has Hold rating according to SA Quant , but scores a buy or strong buy from SA Analysts as well as Wall Street analysts.

Top Aerospace and Defense Stock Pick No. 3 - Rolls Royce

I recently added Rolls Royce to my coverage with a Buy rating and the stock has exceeded expectations beating my price target which could be positioning the company for upside driven by execution and multiple expansion. Rolls Royce is definitely not the biggest player when it comes to aero engines, but it's the exclusive engine supplier for the Airbus A350 and Airbus A330neo while engine flight hours are recovering which will drive services demand. Apart from that the company can likely also count on interest from investors due to its Small Modular Reactor. Energy transition as well as becoming less dependent on certain countries for energy needs are driving demand for nuclear solutions and Rolls-Royce could be playing an important role. That will not materialize in a single year, but positive sentiment coupled with improving fundamentals could boost investor interest in Rolls Royce stock.

Rolls-Royce stock is the only large-cap stock that made it to our buy list and ranks No. 2 in the list of Top Aerospace and Defense Stocks with a SA Quant Rating of Strong Buy and a buy rating according to SA Analysts and Wall Street Analysts . Based on the strong recent performance and using the evoX Stock Screener I have a buy rating with a $4.30 price target equal weighting the company and industry EV/EBITDA.

Bonus Stock Pick: Boeing On Improving Balance Sheet

Last year, I marked Boeing stock as a buy and the company did deliver despite challenges on the Boeing 737 MAX program driven by manufacturing issues at Spirit AeroSystems. With the share price appreciating beyond its fundamentals from an EV/EBITDA perspective, Boeing stock has not made it to the list this year. However, in 2023 we saw that the stock lifted driven by positive developments on gaining access to the Chinese markets and I would expect that there are opportunities in 2024 for the stock as Boeing commercial airplane delivery volumes will get closer to where we had initially expected them to be in 2023 and the overall production system health as well as the balance sheet health will continue to improve. Positive free cash flow could spark investor interests pushing the stock prices higher as Boeing at some point will likely also look to reinstate a dividend again and investors will want to presort for that.

My View On Aerospace and Defense in 2024

2024 without doubt will be another interesting year as we should be able to see whether demand in the defense landscape materializes and we also should see to what extent that affects the top line. Defense tends to provide nice shareholder returns but investors are looking for upsizing in the shareholder returns in the form of expanded buybacks and dividend increases and many large cap defense names have grown a bit ahead of their valuations going forward and even more so for 2024 which in my view does not make large-cap pure defense play the most attractive investment opportunities. However, I do believe that companies with commercial airplane exposure could do significantly better even in a high interest rate environment. The Aerospace and Defense Industry is so big and versatile with different end markets, products and geographical areas served that making a case for the entire industry being a good investment or not is difficult but I do believe that companies with a nice mix of defense as well as commercial exposure provide nice growth opportunities while the defense stocks provide safer compounding opportunities but compounding is something that pays off over the longer term so that's not something that you will see materialize over a year's time. That also is why my picks are leaning more towards growth opportunities than safe investments. That's not to say that safe investments shouldn't be considered, I would definitely consider stocks such as RTX Corporation ( RTX ), Lockheed Martin, Textron, BAE Systems and Northrop Grumman and those names could see share price appreciation if the broader markets puts their investment money in those names. But for growth opportunities I'm simply looking elsewhere in the industry.

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