Aviation & Aerospace Industry Manufacturing Summit (AAIMS) Setting the Stage Rob Spingarn Credit Suisse Aerospace & Defense Equity Research (212) 538-1895, [email protected]October 16, 2013 DISCLOSURE APPENDIX CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, INFORMATION ON TRADE ALERTS, ANALYST MODEL PORTFOLIOS AND THE STATUS OF NON-U.S ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, 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. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION ™ Client-Driven Solutions, Insights, and Access Credit Suisse has decided not to enter into business relationships with companies that Credit Suisse has determined to be involved in the development, manufacture or acquisition of anti- personnel mines and cluster munitions. For Credit Suisse's position on the issue, please see https://www.credit-suisse.com/responsibility/doc/policy_summaries_en.pdf.
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Aviation & Aerospace Industry Manufacturing Summit (AAIMS) Setting the Stage Rob Spingarn Credit Suisse Aerospace & Defense Equity Research (212) 538-1895, [email protected] October 16, 2013
DISCLOSURE APPENDIX CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, INFORMATION ON TRADE ALERTS, ANALYST MODEL PORTFOLIOS AND THE STATUS OF NON-U.S ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, 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.
CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION™
Client-Driven Solutions, Insights, and Access
Credit Suisse has decided not to enter into business relationships with companies that Credit Suisse has determined to be involved in the development, manufacture or acquisition of anti-personnel mines and cluster munitions. For Credit Suisse's position on the issue, please see https://www.credit-suisse.com/responsibility/doc/policy_summaries_en.pdf.
Date: 10/31/2013 Slide 2
My Role as a Sell-side Equity Analyst
Source: Credit Suisse research
• We form the Investment Theses for Stocks/Industries in a Coverage Universe • Traditional sell-side firms such as Credit Suisse (CS) have analyst teams that
cover ~50+ industries. • Aerospace & Defense is 1 of 60 sector teams at CS
• We provide investment recommendations through the following mechanisms: • Buy/Sell/Hold Ratings • Target Prices to value the equity embedded in a company • Earnings & Cash Flow forecasts to define a path to the Target Price value
• Our clients are mutual funds, pension funds, and hedge funds that own and trade stocks. They are collectively known as the “buy side”.
3
Your Role as Aerospace & Defense Suppliers Defense Primes BizJets
Raytheon Company Bombardier Inc.Northrop Grumman Corporation Embraer S.A.Lockheed Martin Corporation Textron Inc.General Dynamics Corporation Dassault Systemes SAHuntington Ingalls Industries, Inc. EnginesAlliant Techsystems Inc. Rolls-Royce Holdings plc
Defense Tier 1 United Technologies CorporatioExelis Inc. MTU Aero Engines AGL-3 Communications Holdings, Inc. Tier 1 CommercialCubic Corporation Honeywell International Inc.
Government Services United Technologies CorporatioBooz Allen Hamilton Holding Corporation Spirit AeroSystems Holdings, InCACI International Inc Triumph Group, Inc.ManTech International Corporation WOODWARD, INC.Leidos Holdings Inc. Zodiac Aerospace SAEngility Holdings, Inc. Safran SAICF International, Inc. B/ E Aerospace Inc.
The KEY W Holding Corporation AftermarketUS Space TransDigm Group Incorporated
Orbital Sciences Corporation HEICO CorporationAlliant Techsystems Inc. Meggitt PLCMacDonald, Dettwiler and Associates AAR CORP.GenCorp Inc. Tier 2 Commercial
European Defense Primes Esterline Technologies CorporaBAE Systems plc Anaren, Inc.Finmeccanica S.p.A. Aeroflex Holding Corp.Saab AB Moog Inc.Thales SA Duocommun Incorporated
European Defense Tier 1 Astronics CorporationChemring Group PLC Curtiss-Wright CorporationRheinmetall AG CrossoverUltra Electronics Holdings plc Rockwell Collins, Inc.
Large Commercial Harris CorporationThe Boeing Company FLIR Systems, Inc.European Aeronautics Defence & Space CAE Inc.
Boeing and Airbus have responded by aggressively selling aircraft For the first time in 30 years average sale quantities are rising rapidly
Date: 10/31/2013 Slide 19
Commercial OE – Key Concerns
Source: Credit Suisse research
We expect that these large orders reflect, to some extent, aggressive pricing, which is causing the OEMs to review their cost structure. At Boeing, this is called “Partnering for Success” So suppliers will need to learn how to raise the bar on quality, value and innovation while lowering prices.
0
200
400
600
800
1000
1200
1400
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
Orders Deliveries
Date: 10/31/2013 Slide 20
Commercial OE – Key Concerns
Source: Credit Suisse research
While all of this is happening, the business jet industry remains in a five-year slump with all of the associated pricing and cost issues without the up-cycle
Commercial Aftermarket
Date: 10/31/2013 Slide 22
Commercial Aftermarket – Traffic & Capacity IATA Forecasts Traffic Growth of 5.3% in 2013 and Capacity Growth of 4.3%
Source: IATA Traffic & Capacity Data
-10%
-5%
0%
5%
10%
15%
20%Ma
y-09
Aug-
09
Nov-0
9
Feb-
10
May-1
0
Aug-
10
Nov-1
0
Feb-
11
May-1
1
Aug-
11
Nov-1
1
Feb-
12
May-1
2
Aug-
12
Nov-1
2
Feb-
13
May-1
3
Aug-
13
Y/Y Traffic Growth Y/Y Capacity Growth
0
50
100
150
200
250
300
350
22
23
24
25
26
27
28
29
# of Retirements (Right Axis) Average Age at Retirement (Left Axis)
Date: 10/31/2013 Slide 23
Commercial Aftermarket
Source: Credit Suisse research
With all of these new aircraft deliveries, retirements are accelerating, and retirement age is dropping, putting viable aircraft & parts to rest
Date: 10/31/2013 Slide 24
Commercial Aftermarket – Surplus Parts Glut
Source: Credit Suisse research
This is creating a two-pronged problem for some suppliers: 1. As fleets get younger, parts for older aircraft are
seeing a demand shortfall. 2. As older aircraft are parked to make room for newer
ones, their parts can cannibalize spares from the original component supplier.
So, suppliers of parts for older aircraft are experiencing pressure that could linger for a while
Defense & Government Services
Defense19%
Medicare & Medicaid
24%
Social Security
20%
Discretionary18%
Other Mandatory
13%
Net Interest6%
North America
37%
Central & South
America4%
Europe25%
Middle East8%
Asia & Oceania
24%
Africa2%
Date: 10/31/2013 Slide 26
Defense – Global Defense Markets
U.S. Defense Spending in the Context of the Federal Budget
The U.S. Accounts for ~Half of Global Defense Spending
Source: SIPRI; The White House
Even with domestic budgetary pressures, the onset of Sequestration, and continued growth in military expenditure by China, the U.S easily remains the biggest defense spender in the world.
Defense accounts for almost 20% of the total US federal budget, and almost half of discretionary spending.
Source: Credit Suisse research, US DOD
Date: 10/31/2013 Slide 27
Defense – Key Positive Considerations
Source: Credit Suisse research
Continued strong cash flows are supporting earnings and keeping shareholders interested International demand has been holding up as the threat environment requires a high level of vigilance everywhere Furthering that point, let’s take a look at Chinese spending on the next slide
Emerging peer China could be a major driver of US defense growth
China’s 10-year growth rate 19.1% compares to 1.8% for the US, with less than half the GDP percentage
Date: 10/31/2013 Slide 29
Defense
Source: Credit Suisse research
But, obviously, there are major issues facing the Defense markets too
Date: 10/31/2013 Slide 30
Defense – Historical & Forecast US Defense Spending
In constant dollars, the FYDP suggests relatively flat topline between FY’14 & FY’18. But, it also implies that the defense topline stays ~$150B above historical troughs. Source: US DOD
0
100
200
300
400
500
600
700
800
FY 48
FY 50
FY 52
FY 54
FY 56
FY 58
FY 60
FY 62
FY 64
FY 66
FY 68
FY 70
FY 72
FY 74
FY 76
FY 78
FY 80
FY 82
FY 84
FY 86
FY 88
FY 90
FY 92
FY 94
FY 96
FY 98
FY 00
FY 02
FY 04
FY 06
FY 08
FY 10
FY 12
FY 14
FY 16
FY 18
KoreaVietnam
ReaganBuild-up
Iraq / Afghanistan
Date: 10/31/2013 Slide 31
Defense – The Budget Deficit
Annual Federal Revenues ~$2.6T Annual Federal Expenditures ~$3.7T Equals an annual ~$1.1T Federal Budget Deficit Sequester may not make a dent in anything but industry
HOLT Shows the Market Expects Better Returns from Defense, with Less Predictability of Growth
Returns on Capital – Next twelve months CFROI
Source: HOLT CFROI framework and global database, FactSet. (1) Sales growth embedded in current market valuation based on consensus sales growth estimates and HOLT DCF model.
Source: HOLT CFROI framework and global database as of October 2013. (1) HOLT price/book is equivalent to current enterprise value/net capital invested which is defined as ([market
value of equity + debt] / [inflation adjusted net assets, including capitalized operating leases]). (2) Defined as CFROI less the cost of capital; next twelve months (NTM) CFROI based on consensus EPS
estimates.
Peer regression R² = 90%
S&P 500 regression R² = 83%
Valuation
Aftermarket (18.3%, 4.72x)
Commercial Defense Mixed
37
The Market Indicates that Defense has Potential for Upside, while Commercial is Already Highly Valued
HOLT
Appendix
Date: 10/31/2013 Slide 39
Aerospace & Defense Valuations
Source: Company data, Credit Suisse research, Factset 7.94x
Companies Mentioned (Price as of 14-Oct-2013) AAR (AIR.N, $27.79) Alliant Techsystems Inc. (ATK.N, $101.55) BAE Systems (BAES.L, 443.8p) BE Aerospace Inc. (BEAV.OQ, $76.78) Boeing (BA.N, $119.46) Bombardier Inc (SVS) (BBDb.TO, C$4.97) Booz Allen Hamilton Holding (BAH.N, $18.96) CACI International, Inc. (CACI.N, $68.37) EADS (EAD.PA, €48.92) Esterline Technologies (ESL.N, $79.47) Exelis (XLS.N, $15.6) General Dynamics Corporation (GD.N, $87.81) Heico Corp (HEI.N, $66.72) Hexcel Corporation (HXL.N, $40.08) Honeywell International Inc. (HON.N, $85.98) Huntington Ingalls (HII.N, $71.3) L-3 Communications (LLL.N, $94.98) Leidos (LDOS.N, $46.27) Lockheed Martin (LMT.N, $127.5) MTU Aero Engines (MTXGn.DE, €70.4) ManTech International Corp. (MANT.OQ, $29.05) Meggitt (MGGT.L, 541.0p) Moby Oil & Gas (MOG.AX, A$0.005) Northrop Grumman Corporation (NOC.N, $98.81) Precision Castparts (PCP.N, $241.51) Raytheon Company (RTN.N, $76.38) Rockwell Collins, Inc. (COL.N, $68.92) Rolls-Royce (RR.L, 1125.0p) Safran (SAF.PA, €45.95) Spirit AeroSystems (SPR.N, $24.71) Textron (TXT.N, $27.29) TransDigm (TDG.N, $140.5) Triumph Group Inc (TGI.N, $71.05) United Technologies Corp (UTX.N, $106.9) Wesco Air Hldg (WAIR.N, $19.76) Woodward Inc (WWD.OQ, $42.07)
Disclosure Appendix
Important Global Disclosures I, Robert Spingarn, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities
As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark*over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; Australia, New Zealand are, and prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, 12-month rolling yield is incorporated in the absolute total return calculation and a 15% and a 7.5% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively. The 15% and 7.5% thresholds replace the +10-15% and -10-15% levels in the Neutral stock rating definition, respectively. Prior to 10th December 2012, Japanese ratings were based on a stock’s total return relative to the average total return of the relevant country or regional benchmark. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances.
Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.
Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors.
Credit Suisse's distribution of stock ratings (and banking clients) is:
Global Ratings Distribution
Rating Versus universe (%) Of which banking clients (%) Outperform/Buy* 42% (55% banking clients) Neutral/Hold* 40% (48% banking clients) Underperform/Sell* 15% (39% banking clients) Restricted 3% *For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors.
Credit Suisse’s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the market that may have a material impact on the research views or opinions stated herein. Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: http://www.csfb.com/research and analytics/disclaimer/managing_conflicts_disclaimer.html Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties.
Please refer to the firm's disclosure website at https://rave.credit-suisse.com/disclosures for the definitions of abbreviations typically used in the target price method and risk sections.
See the Companies Mentioned section for full company names The subject company (ESL.N, LMT.N, HON.N, UTX.N, RTN.N, NOC.N, HXL.N, XLS.N, CACI.N, BAH.N, TGI.N, ATK.N, TDG.N, BEAV.OQ, LLL.N, AIR.N, BA.N, COL.N, GD.N, HEI.N, HII.N, SPR.N, TXT.N) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (RTN.N, NOC.N, BAH.N, TDG.N, BA.N, GD.N, HII.N, SPR.N) within the past 12 months. Credit Suisse provided non-investment banking services to the subject company (LMT.N, HON.N, RTN.N, NOC.N, BEAV.OQ, BA.N, TXT.N) within the past 12 months Credit Suisse has managed or co-managed a public offering of securities for the subject company (RTN.N, NOC.N, TDG.N, BA.N, GD.N, HII.N) within the past 12 months. Credit Suisse has received investment banking related compensation from the subject company (RTN.N, NOC.N, BAH.N, TDG.N, BA.N, GD.N, HII.N, SPR.N) within the past 12 months Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (ESL.N, LMT.N, HON.N, UTX.N, RTN.N, NOC.N, HXL.N, PCP.N, XLS.N, CACI.N, MANT.OQ, BAH.N, TGI.N, ATK.N, TDG.N, BEAV.OQ, LLL.N, AIR.N, BA.N, COL.N, GD.N, HEI.N, HII.N, SPR.N) within the next 3 months. Credit Suisse has received compensation for products and services other than investment banking services from the subject company (LMT.N, HON.N, RTN.N, NOC.N, BEAV.OQ, BA.N, TXT.N) within the past 12 months As of the date of this report, Credit Suisse makes a market in the following subject companies (ESL.N, LMT.N, WWD.OQ, HON.N, UTX.N, RTN.N, NOC.N, HXL.N, PCP.N, XLS.N, CACI.N, MANT.OQ, BAH.N, TGI.N, ATK.N, TDG.N, BEAV.OQ, LLL.N, AIR.N, BA.N, COL.N, GD.N, HEI.N, HII.N, SPR.N, TXT.N, LDOS.N). As of the end of the preceding month, Credit Suisse beneficially own 1% or more of a class of common equity securities of (TDG.N). Credit Suisse has a material conflict of interest with the subject company (UTX.N) . Credit Suisse Securities (USA) LLC is acting as an advisor to Goodrich (GR) in a potential transaction with United Technologies Corp. Credit Suisse has a material conflict of interest with the subject company (LDOS.N) . Credit Suisse has a material conflict of interest with the subject company (SAI). As of the date of this report, an analyst involved in the preparation of this report has the following material conflict of interest with the subject company (SAI). An analyst or a member of the analyst's household has a long position in the common stock of SAIC (SAI).
Important Regional Disclosures Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report. The analyst(s) involved in the preparation of this report have not visited the material operations of the subject company (ESL.N, LMT.N, WWD.OQ, HON.N, UTX.N, RTN.N, NOC.N, HXL.N, PCP.N, XLS.N, CACI.N, MANT.OQ, BAH.N, TGI.N, ATK.N, TDG.N, BEAV.OQ, LLL.N, BA.N, BBDb.TO, COL.N, GD.N, HEI.N, HII.N, SPR.N, TXT.N, LDOS.N) within the past 12 months Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares. Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit http://www.csfb.com/legal_terms/canada_research_policy.shtml. Credit Suisse has acted as lead manager or syndicate member in a public offering of securities for the subject company (RTN.N, NOC.N, TGI.N, TDG.N, BEAV.OQ, BA.N, GD.N, HII.N, SPR.N) within the past 3 years. As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report. Principal is not guaranteed in the case of equities because equity prices are variable.
Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that. CS may have issued a Trade Alert regarding this security. Trade Alerts are short term trading opportunities identified by an analyst on the basis of market events and catalysts, while stock ratings reflect an analyst's investment recommendations based on expected total return over a 12-month period relative to the relevant coverage universe. Because Trade Alerts and stock ratings reflect different assumptions and analytical methods, Trade Alerts may differ directionally from the analyst's stock rating. The author(s) of this report maintains a CS Model Portfolio that he/she regularly adjusts. The security or securities discussed in this report may be a component of the CS Model Portfolio and subject to such adjustments (which, given the composition of the CS Model Portfolio as a whole, may differ from the recommendation in this report, as well as opportunities or strategies identified in Trading Alerts concerning the same security). The CS Model Portfolio and important disclosures about it are available at www.credit-suisse.com/ti.
Important Credit Suisse HOLT Disclosures With respect to the analysis in this report based on the Credit Suisse HOLT methodology, Credit Suisse certifies that (1) the views expressed in this report accurately reflect the Credit Suisse HOLT methodology and (2) no part of the Firm’s compensation was, is, or will be directly related to the specific views disclosed in this report. The Credit Suisse HOLT methodology does not assign ratings to a security. It is an analytical tool that involves use of a set of proprietary quantitative algorithms and warranted value calculations, collectively called the Credit Suisse HOLT valuation model, that are consistently applied to all the companies included in its database. Third-party data (including consensus earnings estimates) are systematically translated into a number of default algorithms available in the Credit Suisse HOLT valuation model. The source financial statement, pricing, and earnings data provided by outside data vendors are subject to quality control and may also be adjusted to more closely measure the underlying economics of firm performance. The adjustments provide consistency when analyzing a single company across time, or analyzing multiple companies across industries or national borders. The default scenario that is produced by the Credit Suisse HOLT valuation model establishes the baseline valuation for a security, and a user then may adjust the default variables to produce alternative scenarios, any of which could occur. Additional information about the Credit Suisse HOLT methodology is available on request. The Credit Suisse HOLT methodology does not assign a price target to a security. The default scenario that is produced by the Credit Suisse HOLT valuation model establishes a warranted price for a security, and as the third-party data are updated, the warranted price may also change. The default variable may also be adjusted to produce alternative warranted prices, any of which could occur. CFROI®, HOLT, HOLTfolio, ValueSearch, AggreGator, Signal Flag and “Powered by HOLT” are trademarks or service marks or registered trademarks or registered service marks of Credit Suisse or its affiliates in the United States and other countries. HOLT is a corporate performance and valuation advisory service of Credit Suisse.
For Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at https://rave.credit-suisse.com/disclosures or call +1 (877) 291-2683.
Investment principal on bonds can be eroded depending on sale price or market price. In addition, there are bonds on which investment principal can be eroded due to changes in redemption amounts. Care is required when investing in such instruments. When you purchase non-listed Japanese fixed income securities (Japanese government bonds, Japanese municipal bonds, Japanese government guaranteed bonds, Japanese corporate bonds) from CS as a seller, you will be requested to pay the purchase price only