ETFs Leading The Aerospace and Defense Sector Higher

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December 13, 2013 6:07pm NYSE:ITA NYSE:XAR

defense stocksIt seems there is no looking back for the U.S. Aerospace and Defense sector. So far this year, the sector has weathered sequestration, defense budget cuts, and cancellation of big-ticket program but it still holds its head high.

Why the Sector is Soaring Higher?

Growing commercial opportunities thanks to an improving global economy, a pickup in defense spending in certain other countries and technological innovations and acquisitions actually made up for the military budget cuts. Meanwhile, from the civilian side, the commercial aircraft fleet is also aging fast which is spurring many companies to upgrade their fleets.

As per Boeing (BA), as much as 41% of the total new deliveries over the long haul will be just to replace the older fleet thus honing the sector’s growth.

Strategic alliances with foreign nations often have the U.S. share its military technology, and supply weapons, to its allies which in turn boost the sector’s revenues.

Lower energy prices in the U.S. is another driver for the sector owing to higher production and lower imports. Overall oil production is booming in North America. According to the EIA, U.S. crude oil production may increase from 6.5 million barrels per day produced in 2012 to 8.5 million barrels a day in 2014.

This means that the U.S. is fast catching up with Russia to be the world’s biggest producer of oil within two years. This bullish data is definitely backing the Aerospace boom (read: Play the U.S. Oil Boom with These Energy ETFs).

Aerospace, which accounts for a very little of the S&P 500 index, just 1.5% in fact, has delivered double-digit earnings growth this season and is poised for decent growth in the coming quarter as well. Approximately three-fourth of the total number of companies in the space has beaten the earnings expectation while 62.5% surpassed the top line.

Most of the funds tracking the sector rewarded investors with almost double the gain than what was offered by the broader market fund SPDR S&P 500 (SPY) in the last one-year period. Given this surprisingly bullish tone, there could still be plenty of time to look at the aerospace and defense stocks to take advantage of the strong trends in the space.

Below we have highlighted two options that can offer solid exposure to the segment in basket form, and may be great picks for investors seeking allocations to this strong trend:

iShares U.S. Aerospace & Defense ETF (NYSEARCA:ITA)

This ETF follows the Dow Jones U.S. Select Aerospace & Defense Index, giving exposure to about 39 companies. The ETF is pretty popular in the space, with nearly $286 million in AUM and average daily volume of about 40,000 shares a day.

The product has a pretty reasonable cost from an industrial equities point of view, charging investors 48 basis points a year.

ITA is a concentrated choice with about 56% shares invested in the top 10 holdings. Boeing (9.7%), United Technologies (8.9%) and Precision Castparts (6.2%) are the top three choices in the basket. Aerospace takes about 55% of the asset base while Defense accounts for the rest.

The fund gained a handsome 49.1% in the year-to-date frame (as of December 3, 2013). ITA has a Zacks ETF Rank #1 (Strong Buy), and a ‘low’ risk outlook.

SPDR S&P Aerospace & Defense ETF (NYSEARCA:XAR)

This product looks to track the S&P Aerospace and Defense Select Industry index, which is a modified equal weight index. This one is not a very popular choice as the product has attracted AUM of $28.9 million so far. Holding 36 securities in its basket, the product invests around 45% of assets in the top 10 holdings.

Its 35-basis point charge is even lower than the iShares product discussed above. Spirit AeroSystems Holdings (5.09%), Alliant Techsystems (4.76%) and The Boeing Co (4.54%) are the top three holdings.
The fund returned as much as 53.5% in the YTD frame. XAR also carries a Zacks ETF Rank #1 (Strong Buy) with a ‘low’ risk outlook.

Bottom Line

While the sector is surging, we still foresee budget cut or sequestration looming large next year. Though the nation has averted another government shutdown for the next year through the latest budget deal, the defense industry might have to bear the brunt of spending cuts for the sake of the country’s creditworthiness.

This would impact some biggies including Lockheed Martin (LMT), Raytheon (RTN) and Northrop Grumman (NOC) as sales of these companies are largely vulnerable to U.S. defense spending.  Till then, investors can ride the recent surge in the U.S. Aerospace and Defense sector easily with the aforementioned ETFs.

This article is brought to you courtesy of Eric Dutram.

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