For major defense and aerospace companies, the second quarter started off with turbulence thanks to sequestration. This week, though, strong earnings from the a pile of defense stocks illustrated that the Pentagon’s biggest contractors are managing to rise above the storm.
The top six U.S. defense contractors — Boeing (BA), United Technologies (UTX), Lockheed Martin (LMT), General Dynamics (GD), Northrop Grumman (NOC) and Raytheon (RTN) all significantly beat analysts’ earnings estimates for the quarter.
Wall Street can be forgiven for its low expectations, too. After all, deep defense cuts already have driven down revenue year-over-year for most companies in the sector and sequestration — the $85 billion in across-the-board federal spending cuts that kicked in on March 1 — was deemed certain to eat these contractors’ lunch.
The fact that their fortunes did not fall off a cliff is largely a testament to two tactics: aggressive cost-cutting and growth in business lines that aren’t solely dependent upon a Pentagon check.
Let’s break down the recent reports further.
Given all the headlines and headwinds Boeing has battled since April, the Grim Reaper should have been the moderator for the company’s earnings call on Wednesday.
After all, BA’s flagship 787 Dreamliner — which was grounded from January to April after lithium-ion battery fires in two jets — suffered yet another fire unconnected to the battery problem earlier this month.
Even so, Boeing’s commercial airplanes unit helped drive revenue up 9% year-over-year, while earnings per share soared by 11% to $1.41 from last year’s $1.27. BA also raised its full-year earnings estimate to a range of $6.20 to $6.40, up from the previous estimate of $6.10 to $6.30.
Although defense cuts slightly hit the company’s revenue, Boeing has managed to grow margins and market share, while managing costs effectively. It doesn’t hurt that commercial aircraft orders are on afterburners now.
Despite a revenue miss, United Technologies beat on earnings and lifted the Dow out of the doldrums on Tuesday. It didn’t hurt that the company also raised the low end of its full-year guidance as well — especially great news since just a few months ago, CEO Louis Chenevert predicted that sequestration would knock a dime off UTX’s full-year numbers.
One reason for UTX’s strong performance is the company’s nearly $600 million restructuring effort it kicked off last year. UTX’s acquisition of B.F. Goodrich last year has also helped by expanding its footprint in the commercial aircraft business.
One of the company’s crown jewels is the innovative Electric Power Generating and Start System (EPGSS) that provides Boeing’s 787 with five times the electric power available to a similar size Boeing 767. Because of it, growth in BA’s order book for the carbon-composite jetliner is good news for UTX.
Lockheed Martin — the largest defense pure play — managed to overcome sequestration and sagging Pentagon spending to post earnings of $2.64 a share, up from $2.38 for the same quarter a year ago and far better than the $2.20 consensus. The company, which also benefited from a lower pension charge, raised its full-year earnings forecast to between $9.20 and $9.50 a share.
Lockheed Martin is heavily dependent on defense sales; its top programs include the F-35 Lightning II Joint Strike Fighter, Littoral Combat Ship, Patriot Advanced Capability-3 (PAC-3) missile and the AEGIS missile defense system.
That’s why LMT’s profitability has been driven by moves to cut overhead costs. For example, although revenue in its mission systems and training business slumped 12%, the company actually was able to boost earnings by 41%. Lockheed Martin continues to battle lagging performance in its information technology and space systems businesses, however.
GD shares gained on Wednesday as the company’s earnings of $1.81 a share topped analysts’ estimates by 19 cents. Not surprisingly, the greatest weakness was in General Dynamics’ combat systems unit. Revenue was down 28% in the quarter as earnings slipped 32%, largely on slower international business.
While cost-efficiency is a critical concern for all defense contractors now, GD’s strong commercial aircraft sales also are helping shareholders sleep well at night. Operating earnings in GD’s aerospace business skyrocketed by more than 50% compared to a year ago and margins grew by nearly 3%.
The growth clearly was driven by stronger performance in the Gulfstream aircraft sales, and GD hopes to boost sales if its new long-range Gulfstream G650 this year.
Next up, Northrop Grumman had a good day on Wednesday too, as it reported earnings of $1.97 a share on a top line of $6.29 billion, blowing away analysts’ estimates of $1.71 on revenue of $5.98 billion.
NOC, whose key defense programs include the Global Hawk unmanned drone, E2-D Hawkeye surveillance aircraft and high-test cybersecurity solutions, offset the pain of overall reduced Pentagon spending with better than expected performance in its aerospace division, where earnings surged 9%.
Northrop Grumman also boosted its full-year EPS guidance despite revising revenue slightly downward to $24 billion. Cost cutting is a huge priority at NOC, and the company has done a great job of raising profitability through layoffs and other measures.
Northrop Grumman also has done a solid job of generating cash, most of which has been distributed to shareholders through share repurchases and dividends. Plus, at the end of last month, NOC had nearly $5 billion of cash on hand.
Last but not least, Raytheon also beat Wall Street expectations yesterday. The company’s adjusted EPS rose from $1.57 in the second quarter last year to $1.64. The company, which derives most of its revenue from military products like the Tomahawk Land Attack Missile and the Patriot Surface-to-Air Missile, also raised its full-year forecast.
Much of RTN’s strong earnings performance can be attributed to cost-cutting measures. The company also has done a good job of taking care of its investors by repurchasing more than 7.5 million shares of its stock so far in 2013.
But Raytheon has managed to grow its integrated defense and missile systems business by looking outside the U.S. for opportunities. Notably, international sales grew by 10% in the quarter and the company sees overseas sales — particularly of its advanced air and missile defense systems — accounting for a growing share of its business.
Headwinds remain, however, as RTN continued to be challenged in its Network Centric Operations and Space & Airborne Systems units because most major U.S. programs are winding down.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.