Finland recently met with five defense contractors bidding on HX Program to help them better understand contract parameters and offset expectations ahead of their preliminary bid. The five OEs and their platforms, in order listed by the Finnish government, are 1) BA F-18, 2) Dassault Rafale, 3) Eurofighter Typhoon, 4) LMT F-35, and 5) Saab Gripen. Ministry of Defence Project Coordinator Lauri Puranen indicated there are no favorites. That said, we believe the Eurofighter consortium will aggressively bid on the contest given its recent Belgium loss, but BA has the advantage of being the incumbent.
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North Korea appears to be moving ahead, maintaining, and improving its network of secret, undeclared ballistic missile operating bases according to an 11/12 report published by Beyond Parallel, a program at the Washington-based think tank Center for Strategic and International Studies (CSIS). The study identified 13 out of an estimated 20 missile bases using commercial satellite images. The first report focused on the Sakkanmol missile based ~80 miles northwest of Seoul. It currently has short-range ballistic missiles, and CSIS believes the missile base “could easily accommodate” medium-range ballistic missiles. The report identified seven purported tunnels to underground facilities that in total could accommodate 9-18 transport vehicles used to move and launch missiles most likely in pre-surveyed locations separate from Sakkanmol. CSIS also noted that Sakkanmol appears to be active and well-maintained based on satellite images as of November.
TDG reported F4Q18 adjusted EPS of $4.44, beating our $4.32E and consensus $4.29. Upside vs. our estimates mainly came from lower interest expense (+$0.08/sh) and higher sales (+$0.03/sh); see Exhibit 1 on p2. Organic GM improved 90bp y/y and seq to 59.7% above our 58.8%E, but this was with heavier SG&A of 12.2% (+90bp y/y and +100bp seq) vs. our 11.1%E suggesting some geographic shift in costs.
The Royal Canadian Air Force (RCAF) released its draft RFP on 10/26 to replace its aging fleet of CF-18s. Five defense contractors are eligible to bid on the contract, and they are in order listed by the Canadian government 1) Dassault, which manufactures the Rafale, 2) Saab (Gripen E/F), 3) Airbus Defense and Space (member of the Eurofighter consortium that manufactures the Typhoon), 4) Lockheed Martin (F-35 and F-16), and 5) Boeing (F-15 and F-18). The RCAF already met with these five contractors and will incorporate their feedback into the formal RFP, which is expected to be released in spring 2019. Initial proposals are due in winter 2019-20, and the RCAF plans to award the contract in 2021-22 with first deliveries expected in 2025.
Last Friday (10/26/2018), Deputy Secretary of Defense Patrick Shanahan confirmed earlier reports that the DoD needs to cut FY20 budget from its $733B working assumption to $700B per OMB Director Mick Mulvaney’s instruction. This represents a 2% reduction from the FY19 budget of $716B and a 5% reduction from the $733B bogey. In addition, Deputy SECDEF Shanahan indicated the $700B number will be held constant through the next future years defense program (i.e., DoD’s term for its 5-year projections). Under this scenario, modernization would likely take a hit.
We updated our A&D models to include quarterly 2019 estimates as investors begin to focus more on next-year’s top-line and margin cadence and their implications on cash flows rather than the current year’s performance. Also this past weekend, HRS and LLL announced plans to merge, creating the sixth largest U.S. defense contractor. This news buoyed the defense industry and reflects optimism around growing defense budgets. On a scale of 1 to 10 (1=awful) based on the tone of investors during the week, we rate investor sentiment at 5/10, flat week-over-week.
TDG to acquire ESL for $4.0B consisting of $3.6B in cash (at $122.50/sh) and $385M of assumed net debt. The not-terribly-surprising deal is expected to close in 2H19. ESL will be TDG’s largest deal to date (McKechnie previously was the biggest at $1.27B). TDG expects to finance it with cash on B/S and new debt with the mix estimated at ~50/50 and ending net leverage at 6.5x. The implied EV/EBITDA multiple is 12.5x on consensus FY19E, putting it just above the high end of TDG’s target 9-12x deal range.
The Future Attack Reconnaissance Aircraft Competitive Prototype (FARA CP) is a new development effort by the Army to replace the venerable OH-58 Kiowa that was retired in 2017. FARA is an optionally manned, armed recon helicopter tasked with breaching adversaries’ integrated air defense systems. It also has the ability to hide in “radar clutter” and operate in “urban canyons of mega cities.” FARA is a “knife fighter” of future Army aviation capabilities.
We scrubbed H.R. 302 (the FAA reauthorization bill likely to become law in the coming weeks) last week and highlighted key takeaways that mainly impacted airline stocks. While airlines are certainly impacted by this legislation, so are many aerospace names. We see impacts relating to aircraft noise regulations, potential retrofit mandates, supersonic aircraft, and even an effort to improve the FAA certification process for new airplanes.
Last week at an industry conference, Air Force Secretary (SECAF) Heather Wilson announced the need to field 386 squadrons by 2030 to address growing threats from China and Russia as they develop new technologies and acquire modernized assets that erode U.S.’ historical competitive advantage. This aspirational fleet size represents a 24% increase (or an incremental 74 operational squadrons) with growth coming from C2ISR, tankers, rescue helicopters, fighters, special operations, space, and bombers. As SECAF Wilson puts it: “Our operational squadrons are the clenched fist of American resolve.”
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