June 20, 2018 / 1:38 PM / a year ago

Looking for another Nasdaq? Try Europe's aerospace and defense stocks

MILAN (Reuters) - Fat order books covering several years of sales have made European aerospace and defense firms a winning bet as a slowing economy and political instability have clouded prospects for the region’s equity market.

FILE PHOTO: German Air Force Eurofighter Typhoon takes-off during the air policing scramble in Amari air base, Estonia, March 2, 2017. REUTERS/Ints Kalnins/File Photo

The sector’s stock prices have been hitting record highs, even as investors become more wary of European economic growth falling from its peak and as fears of a global trade war put other big multinational industrial stocks in the crosshairs.

For many investment funds, the aerospace and defense sector is more insulated from the economic cycle as it works through a huge backlog of orders and fractious geopolitics spur demand for military equipment.

“Order books are currently very large (and this) gives visibility and makes the group somewhat more resilient from the general economic cycle,” said Sandrine Perret, strategist at Credit Suisse, International Wealth Management, in Zurich.

“It gives the aerospace sector a comparative advantage relative to others that are more sensitive to short-term business fluctuations,” Perret added.

On top of that, while U.S. President Donald Trump’s trade protectionism raises uncertainty about future U.S. demand, that could be more than offset for European firms from countries seeking to reorientate trade away from Washington.

The European aerospace and defense index .SXPARO is up 15 percent so far this year, just below the all-time peak touched last week when the European Central Bank cut its growth forecasts following four months of largely weaker-than-expected economic data .CESIEUR.

That has put the sector ahead of others not only in Europe, but also in the United States. The record-breaking Nasdaq .NDX, for example, is lagging with a 13 percent year-to-date gain.

A number of stocks in the sector, from plane maker Airbus (AIR.PA) to French defense electronics group Thales (TCFP.PA) and German engine firm MTU Aero Engines (MTXGn.DE), have been surging from one record to another.

“Investors are very happy and companies are delivering,” said Celine Fornaro, head of European Industrials equity research at UBS in London. “The sector is long-cycle, less exposed to the volatility of the quarters.”

Airbus’s commercial order book of more than 7,100 jetliners currently represents a record eight years of anticipated production.

And defense companies have once again begun selling more than they deliver, in a sign growth is returning to the sector amid tensions between the West and Russia.

For graphic on a winning bet click reut.rs/2JQptM1


Europe-based companies are also getting a lift from the stronger dollar, which is being underpinned by the U.S. economy’s outperformance versus Europe and prospects for more interest rate hikes by the U.S. Federal Reserve.

Credit Suisse’s Perret said European manufacturers sell aircraft and retail parts in dollars, while their production costs are largely in euros.

This helps explain why the European aero-defense stocks are on track to outperform their U.S. peers this year, although she said the currency tailwind may be short-lived.

“We foresee the euro rebounding against the dollar over the next three months.” said Perret.

Nevertheless, Europe’s aero-defense index is on track to beat its U.S. equivalent .SPLRCAERO for the first time since 2015. The U.S. index, which tracks companies such as Airbus rival Boeing (BA.N) and security firm Lockheed Martin (LMT.N), is up 3 percent so far in 2018, one fifth of the European rise.

Overall, analysts and investors remain upbeat about prospects for the industry and broker sentiment over stocks such as Rolls-Royce (RR.L) and Cobham (COB.L), which have lagged the sector, has improved.

Several analysts lifted their share price targets for Rolls-Royce on Monday after the UK engineer, which has been in turnaround mode since 2015, announced new mid-term goals.

Cobham shares shot up on the same day after Morgan Stanley upgraded the stock, citing the company’s turnaround and the start of “multi-year upcycles ... in core defense and aerospace markets”.

According to research firm Forecast International, European defense spending is seen rising by more than 3 percent a year to $277 billion in 2022, as NATO countries in Europe are under pressure from Washington to increase spending.

Trade body IATA, meanwhile, sees air passenger numbers doubling to 7.8 billion in 2036.

UBS’s Fornaro sums up the mood.

“We’re very upbeat because more people fly and in more countries. Nothing is really new in this industry but it’s hard to say what could stop the cycle,” she said.

“Past cycles were brought to an end by unpredictable events: the 9/11 attacks and the SARS outbreak in 2008,” she added.

For graphic on a record-breaking year click reut.rs/2K3XuER

Reporting by Danilo Masoni; Additional reporting by Tim Hepher in Paris; Editing by Mark Potter

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