Defense stocks could see ‘very favorable’ lift via tax reform: Baird

Defense contractors could be large winners via the tax reform packages, with Raytheon along with Northrop Grumman among the “top beneficiaries,” according to a report issued Monday.

“The impact of the pending corporate tax reform to a 20 percent rate could be very favorable for most aerospace along with defense companies within our coverage universe with domestic-oriented defense companies well positioned for higher earnings,” said Peter Arment, an industry analyst at Baird Equity Research.

With the lower rate, Baird estimates in which defense companies could see an average earnings per share benefit over the 2018-2019 period of 8 to 13 percent. The defense sector on average generates about 76 percent of its revenue domestically.

Arment estimates the “potential upside impact” on defense stocks could be an average 8 percent move, although the report points out Raytheon along with Northrop could see even bigger advances along with Boeing much less.

Even so, Boeing that has a tax rate currently above 30 percent could still benefit via tax reform, Arment wrote. Yet given the commercial aircraft some sort of’s higher international exposure in which could see “the smallest” boost among the big defense names, according to report.

At the same time, the analyst said the lower tax rate also could serve as “a strong incentive to repatriate cash to fund R&D efforts, certain program production expansions, general domestic investment along with capital redeployment (especially buybacks along with M&A).”

The Senate passed its tax overhaul proposal on Saturday after the House earlier approved its own tax reform legislation. A conference committee currently is usually tasked with ironing out differences between the two bills.

Overall, Arment estimates the current average tax rate for the aerospace along with defense group is usually about 28 percent. The analyst sees Northrop along with Raytheon as “top beneficiaries” along that has a few smaller-, mid-cap players, including BWX Technologies, Spirit AeroSystems along with TransDigm Group.

In October, Raytheon, in updating its 2017 financial outlook, said in which its effective tax rate was likely to be about 30 percent. Under tax reform, though, the maker of the Patriot air defense missile system could likely see a lower tax rate in 2018.

Northrop, which is usually building the Air Force’s top-secret B-21 stealth bombers, has an estimated tax rate for 2018 of about 29 percent, although Baird estimates in which could shift lower under the tax reform proposals along with give the company potentially an EPS benefit of 10 percent.

According to Baird’s Arment, BWX along with Spirit AeroSystems could be well-positioned to benefit via tax reform by having a high domestic revenue base. He estimates in which EPS for the two could be revised upward by more than 10 percent.

Lockheed Martin along with General Dynamics, which both average about 27 percent tax rates, could see potential EPS improvements of 7 to 8 percent, Baird estimates.

Baird estimates Boeing’s projected tax rate of 32 percent could come down along with could end up helping to benefit earnings by about 5 percent.

Similarly, the researcher estimates in which Honeywell International along with United Technologies could see potential EPS improvements of 4 percent along with 6 percent, respectively.

The “less favorable” tax rate cut for Boeing, Honeywell along with United Technologies is usually due to the three large aerospace manufacturers having an average domestic revenue base of about 53 percent, Arment said. However, the analyst said the three aerospace giants could see a “positive” impact on the repatriation rules under tax reform.

“Both UTX an HON possess the majority of their cash overseas, which totals $8.5 billion along with $10 billion, respectively,” the analyst wrote. “HON has also commented in which that has a favorable change from the repatriation rules [in which] could bring all options on the table via major M&A to large share repurchases.”

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