UBS has favorable outlook on Aerospace and Defense, favors Boeing, Lockheed

UBS analyst Myles Walton started coverage of the Aerospace and Defense sector with a favorable outlook as he believes the group can support 5%-plus organic growth through 2020. Among the companies under his coverage, Walton initiated Boeing (BA), Lockheed Martin (LMT) and United Technologies (UTX) with Buy ratings, and Hexcel (HXL), Triumph Group (TGI) and Wesco Aircraft (WAIR) with Sell ratings. FAVORABLE OUTLOOK FOR THE GROUP: In a research note to investors, UBS' Walton initiated coverage of the Aerospace and Defense sector with a favorable outlook, though he believes selectivity is important with the sector exhibiting late-industrial cycle characteristics. Within Commercial Aero, the analyst argued that industry dynamics include a "tug-o-war on economics" between suppliers and OEMs. In defense, industry dynamics are not significantly changing, but the budget is, he contended. Walton noted that the Department of Defense's weapons budget is up 40% in three years, but spending outlays are up just 10%, highlighting acceleration in revenues through 2020. After four years of defense budget expansion, the market is "too quick to dismiss" prospects of further growth, the analyst added, saying he believes defense spend will accelerate into 2019, which will favor Lockheed Martin, Raytheon (RTN) and Huntington Ingalls (HII) the most. Meanwhile, Walton pointed out that the 14-year reflation of air transport demand continues, fueled by EM growth, a developed world refresh-cycle stimulated by new products, profitable customers, high oil and favorable duopoly dynamics. The analyst also highlighted that his proprietary survey on aircraft buying intentions provides a supportive view of the current OEM product offerings and the lack of competition, with 88% seeing competition for Boeing and Airbus (EADSY) more than 10 years away. Boeing, TransDigm (TDG), Spirit AeroSystems (SPR), Barnes Group (B) and United Technologies are the most favored name is aerospace, he contended. His top defense pick is Lockheed Martin, while his top aerospace pick is Boeing. BUY BOEING, LOCKHEED: UBS' Walton initiated coverage of Boeing with a Buy rating and $515 price target, citing positive cycle dynamics, competitive position and capital deployment that leave shares with the best upside in Aerospace and Defense. Walton also started coverage of Lockheed Martin with a Buy rating and $400 price target, saying he sees EPS growth of 23% through 2020 with about half of that coming through favorable pension dynamics on top 12% underlying operational earnings growth. Additionally, the analyst initiated coverage of United Technologies with a Buy rating and $160 price target as he expects to see solid growth through 2020 and shares to outrun the market as earnings growth returns and cash performance improves. Barnes Group, Huntington Ingalls, Raytheon, TransDigm, and Spirit AeroSystems were also initiated with Buy ratings. SELL HEXCEL, TRIUMPH GROUP: Meanwhile, Walton initiated Hexcel with a Sell rating and $65 price target as he sees decelerating sales growth and limited margin expansion. As a pure-play aero composite manufacturer, scarcity value is high and a takeout is possible, but he is inclined to see minimal upside from current levels on underlying fundamentals. Triumph Group was also initiated with a Sell rating and $19 price target, with Walton citing the persistent cycle of out-year cash flow disappointments and little to no benefit from $200M of past restructuring. Lastly, the analyst started Wesco Aircraft with a Sell rating and $11 price target as margins collapsed from 20%-plus to 6%. ON THE SIDELINES: UBS' Walton started Northrop Grumman (NOC), Harris (HRS), Heico (HEI), Bombardier (BDRBF), General Dynamics (GD), L3 Technologies (LLL), Curtiss-Wright (CW), and Embraer (ERJ) with Neutral ratings. PRICE ACTION: In morning trading, shares of Boeing, Lockheed and United Technologies have gained 3%, 2% and 1%, respectively. Meanwhile, Hexcel and Triumph Group have dropped about 1%, and Wesco has slipped over 4%.