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Parts for planes
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October 26, 2001: 7:40 p.m. ET
Honeywell and United Technologies are key subcontractors for the biggest defense project ever.
By Michael Sivy
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NEW YORK (CNNmoney) - After the market closed on Friday, the Defense Department announced the winner of the largest military project in history -- the $200 billion Joint Strike Fighter. This plane will be a mainstay for three branches of the U.S. armed forces as well as the U.K.'s navy and air force.
Lockheed-Martin was the big winner -- but it wasn't the only one. Boeing, which also had bid on the project, will likely make parts of the plane. And a host of other defense companies stand to benefit from subcontracting deals. United Technologies is virtually a sure thing, since that company's Pratt & Whitney division was set to provide engines for both the Lockheed and the Boeing proposals. Honeywell is also expected to be a major subcontractor.
Both Honeywell and United Technologies look like irresistible buying opportunities for contrarian investors with a time horizon beyond three years or so. The stocks got clobbered after Sept. 11 because both companies make important components used on commercial aircraft. With airlines reeling from the drop-off in travel, the near-term outlook for that market is dim.
From a longer-term perspective, however, demand for aircraft engines and subassemblies should be just dandy. Even before the war on terrorism, U.S. military spending was slated to rise over the next few years. And after the twin towers fell, another $20 billion was added to the budget for the current fiscal year.
It's also important to realize that the commercial market won't stay depressed for more than a couple of years. Reporting its biggest loss ever on Wednesday, American Airlines' parent AMR said that it had cut back flights by 20 percent and that it was postponing 29 of the 45 new plane deliveries scheduled for 2002. Air travel will eventually recover, however, and planes do wear out. That means that delayed deliveries do have to be made up within two or three years.
United Technologies (UTX: up $2.54 to $57.01, Research, Estimates) gets 36 percent of its earnings from Pratt & Whitney engines and 18 percent from Sikorsky helicopters and aircraft control systems. The rest comes from air-conditioning and elevators. Although the stock price has rebounded from its lows, it's still down 14 percent from its Sept. 10 close. At a current $57 a share, the stock is trading at less than 16 times next year's earnings, which are projected to be down slightly from this year's results. Over the next five years, however, earnings growth could average as much as 15 percent annually.
Honeywell's (HON: up $1.00 to $30.00, Research, Estimates) outlook is much the same, although the stock is also reeling from the aftershocks of its failed merger with General Electric. After the deal was stopped by European regulators, the stock dropped from $50 to $35. It fell again to $24 after Sept. 11 before rebounding somewhat.
CEO Michael Bonsignore left Honeywell after the merger failed and previous CEO Lawrence Bossidy was called back into service. Bossidy is making tough restructuring moves that are hurting current results but will leave Honeywell even better positioned for the next upturn in aerospace, which accounts for 40 percent of Honeywell's sales and an even larger percentage of earnings. Currently $30 a share, Honeywell is trading at 15 times 2002 earnings, which are expected to be flat with this year's. Long-term growth is projected at 14 percent annually.
Given the tough times that are likely before aerospace rebounds, it may be a little bit early for both these stocks. But for an investor with a long-term time horizon, the P/Es look awfully cheap compared with potential growth rates.
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