Which stock has the safer long-term prospects: the commercial aerospace company or the defense giant?
Comparison of commercial aerospace giants GE Aerospace (EN) with leading defense company Lockheed Martin (LMT 0.56%) is always interesting because it requires you to look at the bigger picture. It’s not about earnings for a quarter or even a year; it’s about taking a long-term look at how each company makes money. So let’s dive in and see what we can find out.
The better share
Spoiler alert: GE Aerospace, maker of aircraft engines, is the better stock. While not everyone will agree with that conclusion, the debate will shed some light on the long-term investment opportunities for each stock.
GE Aerospace operates in the commercial aviation industry, an indispensable part of the global economy. Although airlines have not always been such good investments and the industry has experienced periodic cyclical ups and downs, airlines have traditionally had no problem taking on debt (not least because the debt is backed by valuable assets, namely the aircraft themselves).
In addition, there is no way around traveling by plane if you want to cover long distances quickly.
GE Aerospace’s market position
This puts GE Aerospace in an industry where there are only two truly global aircraft manufacturers. Boeing And airbusThis means that the company has a high level of security regarding its development programs. At the same time, there are numerous end customers, including the airlines themselves. As mentioned above, even if some airlines fail, there are usually others that are supported by bondholders.
With engines for both large narrow-body aircraft – the Boeing 737 MAX and the Airbus A320 neo family (RTX also offers an engine for these aircraft) – GE Aerospace is optimally positioned to generate lucrative aftermarket revenues from its installed engine base for many decades to come.
Aircraft engines can last for over 40 years and generate revenue from spare parts and services during that time through overhaul and repair. This creates extremely favorable end-market conditions because GE Aerospace has a high degree of certainty regarding the development of its engines (which are sold primarily to Boeing and Airbus programs) and a high degree of certainty regarding its end market because the company can diversify and reduce risk by selling the engines to many different airlines.
Lockheed Martin: This time it is not the same
For investors who don’t believe in coincidences, there’s a lot to consider when it comes to major defense companies. Boeing’s defense business continues to make losses, particularly on fixed-price development programs. Meanwhile, RTX’s defense business also continues to struggle with profit margins and recently had to take a hit from the termination of a fixed-price development program in its defense business. RTX also lowered its overall 2024 free cash flow forecast due to this issue.
The bulls argue for Lockheed Martin
Let’s get back to Lockheed Martin: The defense company has also had problems with margins in recent years. Management expects margins to bottom out in 2024, and according to CFO Jesus Malave at the last earnings call, the company expects margins to “gradually improve over the next few years.”
Recent margin problems among defense companies are challenging investors’ view of defense stocks. Investors like defense stocks because they are seen as a relatively stable industry with solid growth prospects and low market risk because their customers are sovereign governments.
Image source: Getty Images.
Bulls among defense contractors will argue that the recent margin pressure is targeting fixed-price development programs that were procured in less inflationary times. In addition, defense contractors are particularly affected by supply chain problems, rising raw material prices and problems with product availability (for example, rocket motors or titanium castings).
Bulls argue that margins will improve once these issues subside and Lockheed Martin and others work through fixed-price programs.
The bear arguments for Lockheed Martin
The opposing side points out that the margin deterioration appears to have been there before anyone had heard of the pandemic. Moreover, many other industrial companies have overcome supply chain difficulties and raw material prices, but the defense industry is struggling much more – suggesting that this is a structural rather than a temporary problem.
LMT Gross Profit Margin – data by YCharts
Given the seemingly ever-increasing national debt, there is also a noticeable tendency to impose fixed-price programs on defense companies. This is a real problem, because it indicates that the industry will have to prepare for structurally lower margins in the long term.
GE Aerospace vs. Lockheed Martin
All in all, investors have reason to be concerned until the issue of structural profit margins in the defense industry is resolved. Despite the economic risk in the civil aviation industry, GE Aerospace is the better buying opportunity as the long-term earnings growth trajectory appears more secure.
