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UK Aerospace & Defence
2009 UK Sector Outlook - stay
underweight commercial
Benjamin Fidler
Research Analyst
(44) 20 754 56727
ben.fidler@db.com
Sebastien Gruter
Research Analyst
(44) 20 754 73133
sebastien.gruter@db.com
Remain underweight commercial aerospace, overweight defence
Being a geared play on GDP, we remain bearish on commercial aerospace driven
by airline weakness and continued aircraft financing risks. We have further cut our
commercial aircraft OE and aftermarket forecasts driving underlying earnings
downgrades, albeit partially offset by the $. Although commercial aerospace
multiples may have troughed, forecast risks remain and we would remain
underweight commercial. We retain our overweight stance on Defence, where
near-term earnings risk is lower and valuation appealing.
Deutsche Bank AG/London
All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local
exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche
Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm
may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single
factor in making their investment decision. Independent, third-party research (IR) on certain companies covered by DBSI's research
is available to customers of DBSI in the United States at no cost. Customers can access IR at
http://gm.db.com/IndependentResearch or by calling 1-877-208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARE
LOCATED IN APPENDIX 1.
Industry Update
Top picks
BAE Systems Plc (BAES.L),GBP354.25 Buy
Rolls-Royce Group PLC (RR.L),GBP324.25 Sell
Cobham (COB.L),GBP198.60 Buy
Ultra Electronics (ULE.L),GBP1,155.00 Sell
Global Markets Research Company
Commercial aerospace outlook bleak. Forecasts cut further but risks remain
History shows that although air traffic outperforms GDP in upcycles it
underperforms GDP during economic downturns. Reflecting this, we continue to
expect negative air traffic growth in 2009, forecasting a 3.5% decline. The
resulting global airline overcapacity this generates, allied to the $10-15bn aircraft
financing shortfall we still see for 2009, has led us to further cut aircraft delivery
and aftermarket growth forecasts for commercial aerospace. We now believe
underlying commercial aircraft deliveries will fall in 2009 over 2008. If aircraft
finance markets remain dysfunctional through H209, we would not rule out further
downside risk to our delivery forecasts.
Lessons from history – too early to yet buy commercial aerospace recovery
Analysis of historical cycles shows that commercial aerospace stocks are only
likely to start outperforming once at least two quarters of positive air traffic growth
emerge. We do not expect such a return to positive traffic growth until H209. For
investors seeking to play commercial aerospace recovery in H2, we would
highlight our preference for those shorter cycle stocks with greater aftermarket
focus, low near-term FX hedging and appealing valuations.
Overweight defence, underweight commercial. See p5 for TP/ratings
Although we recognise the longer-term risk of defence budget cuts, the far greater
near-term earnings certainty which Defence stocks offer is still not adequately
reflected in valuations in our view – trading merely in line with the market. We
retain our overweight stance toward Defence. Our top picks in UK Defence are
BAE (BUY, TP 480p) and Cobham (BUY, TP 220p). Ultra Electronics (SELL, TP
1,000p) is our only sell rated stock in the UK Defence subsector, driven by
valuation. We remain underweight on commercial aerospace. Although
commercial aerospace stocks now trade in line with prior cycle trough multiples,
we expect weak macro/airline newsflow will continue in the coming two quarters
and still see forecast risks, despite the cumulative 35% underlying downgrades
made since Jan 2008 to commercial aerospace earnings. Our key sell rating in UK
commercial aerospace is Rolls-Royce (SELL, TP E260p).
Valuation and risks
We continue to use sum of parts as our primary valuation methodology for the
sector. Key risks to our negative stance on commercial aerospace would come
from stronger than expected economic growth emerging in 2009 or further
material US$ strengthening versus UK£. Downside risk to our positive stance on
defence would come from earlier and more material cuts in Defence budgets.
Table of Contents
Investment summary ........................................................................ 3
Highlights of what’s changed in our 2009 outlook......................... 4
Air traffic outlook: -3.5% growth expected for 2009 ...................... 6
Rising aircraft overcapacity puts OEM backlogs at risk............... 10
Aircraft financing – a material pressure point on OE cycle.......... 15
Further downgrades made to OE delivery forecasts.................... 22
Aftermarket likely to see greater downside in 2009..................... 25
Defence – outlook for budget fundamentals for 2009-11............. 28
Forecasts downgraded ................................................................... 39
Valuation & when to buy commercial aero recovery................... 41
Companies ....................................................................................... 48
BAE SYSTEMS (Buy, TP 480p) – Defensive appeals and $ bonus ..........................................48
Cobham (Buy, TP 220p) – High quality & robust organic growth............................................49
Meggitt (Hold, TP 175p) – One to watch when sentiment turns ............................................50
Rolls-Royce (Sell, TP 260p) – Less cyclical than most, more cyclical than appreciated ..........51
Ultra Electronics (Sell, TP 1000p) – Defensive quality…but overpriced ..................................52
VT Group (Hold, TP 545p) – Further progress towards a pure support services play .............53
Appendix A: Financing risks ........................................................... 54
Appendix B: Assessing pension risks ............................................ 56
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