On Monday (1/14/2019), the Indonesian Navy recovered the cockpit voice recorder (CVR) from the Lion Air 737 MAX that crashed on 10/29/18 killing all 189 people on board. Investigators with Indonesia’s National Transportation Safety Committee (KNKT) are optimistic the CVR will provide more information leading up to the crash, particularly around the pilots’ actions to counteract the MAX’s anti-stall system. The investigation will take several months to complete.
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Conventional wisdom suggests a divided Congress is generally good for stocks since Washington gridlock helps to prevent one party from enacting too much disruptive change. We analyzed historical price data for the S&P 500 and select A&D stocks over two intervals: 1929-2018 and 1973-2018. This allows us to capture 1) long-term historical trends spanning multiple economic cycles and elections and 2) a shorter timeframe but one including average annual returns for A&D stocks. We also looked at data on a calendar year basis (Jan 1st to Dec 31st) and on an annual basis in the year starting on the second Tuesday of November (an “election day cycle”). We opted for the latter since that timing is more closely aligned to changes in the political landscape.
President Trump told SECDEF Mattis to submit a $750B budget proposal for FY20 following last Tuesday’s (12/4) meeting at the White House, which included both chairmen of the House and Senate Armed Services Committees (HASC/SASC). This marks a reversal from Trump’s prior stance when he and OMB Director Mick Mulvaney instructed the DoD to cut spending to $700B down from the DoD’s prior $733B working assumption and FY19’s $716B, a level which Trump tweeted as “crazy” on 12/3. For now, the DoD appears to be focused on a $733B budget proposal.
Lion Air co-founder Rusdi Kirana was reportedly “furious” with BA in what he views as BA’s effort to shift blame from the OE and its recent design changes to Lion Air and the airline’s maintenance practices and pilot training. This emerged a couple days after Indonesia National Safety Transportation Committee (KNKT) released its preliminary accident report that indicated the same plane was deemed not airworthy since it experienced similar problems in a separate flight operated the day before by a different flight crew. While KNKT didn’t provide a reason for the crash, we believe it is leaning toward faulting Lion Air, given the airline’s spotty safety record. We believe Kirana/Lion Air’s 737 order review posturing is designed to pressure BA from being more vocal, and we don’t expect the airline to actually cancel its orders for 190 737s (which represent 4% of BA’s 737 backlog) en masse.
Yesterday (11/26/2018) after market close, UTX announced plans to separate into three independent companies (UTC, Otis, and Carrier) after it closed the COL acquisition. (Link here to a UTX update by Nigel Coe, our multi-industrials analyst).
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.
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.
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.
BA, GD, and NOC (all OP-rated) reported 3Q earnings today. NOC was the cleanest, BA probably the best, and GD didn’t help its negative sentiment. We raise key estimates for NOC and BA but trim for GD.
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