European Aero & Defence - 2017
Turning more constructive on Civil Aero; remain selectively positive on Defence
* Civil Aero – what changed? (1) Whilst programme execution is still a risk for ECA in 2017, comments from some companies in late 2016 (e.g. MTU, Zodiac) suggest they are closer to the end of “the great product transition”
that has challenged the industry since 2014. (2) Many airlines lowered profit guidance / deferred aircraft deliveries in 2016, and some airlines could do this in 2017; but an improving economic backdrop probably provides respite to the airline industry as a whole. (3) The rally in the $ vs the euro and sterling in late 2016 is positive for the earnings of ECA companies.
* European Defence – many positives: (1) We believe a multi-year upturn in global defence spending is about to begin. (2) European Defence trades at a notable discount to US Defence. (3) Potential for significantly lower tax
rates in the US and UK. (4) UK Defence companies enjoy a 3-4% yoy benefit to 2017E EPS if the FX rate remains $1.25/£1.
* Airbus – upgrade to Neutral (PT to €68 from €55): Our comments above (“What’s changed?”) all apply to AIR as we enter 2017. But we still believe AIR has above average near-term execution risk and still see some downside risk to 2018E consensus. Hence, we upgrade to Neutral rather than OW.
* Dassault Aviation – upgrade to OW (PT to €1260 from €1100): DA’s shares underperformed in 2016 as investors digested a weak business jet market and slippage to fighter jet deliveries. 2017 should be another challenging year, but we think investors can now focus on 2018 and 2019. We see 2019E EBITA at 2x that of 2017E, driven by rising fighter jet
deliveries and better FX rates. Our updated SOTP model suggests attractive upside for the shares by end 2017.
* MTU Aero Engines – reiterate OW (PT to €140 from €125): We only upgraded MTU to OW on December 15, 2016, and take this opportunity to reiterate our more positive view. 2014-17 is a major investment period for MTU. But investors should now focus on the growth in EPS and FCF that MTU should yield from 2018. Our higher PT mostly reflects the improved FX rate (to $1.05/€1 from $1.10/€1).
* Zodiac – upgrade to OW (PT to €25.5 from €22): ZOD has been the 2nd worst performing ECA stock over the last two years as cost overruns put a major dent in EBITA for YE Aug 15 to Aug 17E. In late 2016, ZOD said it would return to more “normal” levels of profitability in YE Aug-18. We believe this is credible. Our higher PT mostly reflects an improved FX rate.