JPMorgan: Aerospace & Defense 'Has Legs,' We're Going Long

In a report published Tuesday, JPMorgan analyst Seth Seifman commented on the Aerospace and Defense sector, noting that valuations on certain companies "aren't cheap" but "are not especially expensive either."

According to Seifman, the Commercial Aerospace "up-cycle" is expected to continue and the opportunity for double-digit gains over the next 18 months can still be found as the "aero cycle has legs."

"Production increases should lead manufacturers to build seats amounting to approximately eight percent of the installed base annually for 2015-2019, and we see the market absorbing these planes based on approximately five percent traffic growth and approximately three percent replacement," Seifman wrote. "We also assume OEMs and suppliers execute this ramp reasonably well, as they have thus far."

Seifman said that the Defense sector's discount to the S&P 500 is "gone" while cash return yields have "likely topped out." Nevertheless, the defense budget is set to increase again and companies will continue returning cash to investors as management teams are looking to "augment" their return commitments with other capital deployment activity.

Related Link: Boeing Remains Jefferies 'Franchise Pick,' But Firm Tweaks Industry Forecasts

Coverage Initiation

Seifman initiated coverage of both Boeing Co (NYSE: BA) and Spirit AeroSystems Holdings, Inc. (NYSE: SPR) with Overweight ratings.

Boeing should benefit from "solid" aircraft demand that "provides a backdrop" for cash flow growth which will be returned to shareholders through dividends and buybacks. Further production increases at AeroSystems should "help management continue the transition" that is already underway.

Shares of General Dynamics Corporation (NYSE: GD) and Lockheed Martin Corporation (NYSE: LMT) were also initiated with Overweight ratings.

Seifman noted that General Dynamics' balance sheet "might drive upside" while Lockheed Martin could use its "financial strength" to create value. On the other hand, Northrop Grumman Corporation (NYSE: NOC) was initiated with an Underweight rating as the analyst sees "fewer arrows left in the quiver" and expectations may be too high following recent outperformance in its shares.