Chill persists in US aerospace and defense stocks! JP Morgan warns: cloudy military spending outlook and cooling aviation demand mean even strong Q3 results may not reverse the downturn.

JP Morgan believes that aerospace and defense companies are about to face a challenging third-quarter earnings seasonslowing air passenger traffic growth, uncertainty over the outlook for U.S. military spending, and persistent supply chain constraints are all weighing on investor sentiment. In a research report released on October 8, Seth M. Seifman, JP Morgan's chief aerospace and defense industry analyst, said most companies should be able to deliver solid quarterly results and express confidence in underlying demand. However, even encouraging earnings performance may not be enough to reverse the sector's recent stock price weakness. Seth M. Seifman wrote: "The market is near record highs, but aerospace and defense stocks performed weakly in the third quarter, and market sentiment has also deteriorated." The analyst listed Howmet Aerospace (HWM.US), Honeywell Aerospace (HONA.US), Huntington Ingalls Industries (HII.US), and Lockheed Martin (LMT.US) as stocks that could outperform during the earnings season. JP Morgan also downgraded Leidos Holdings (LDOS.US) from "Overweight" to "Neutral," citing deteriorating earnings expectations for the company. For investors, this report highlights the growing divergence within the industryaerospace manufacturers benefit from production growth, defense contractors are supported by long-term weapons demand, while government services companies face pressure on revenue and profitability. Even good earnings may not be enough to lift sector sentiment The broader message from JP Morgan is that although underlying demand for aerospace and defense companies is generally favorable, they still face an unusually difficult earnings environment. Commercial aerospace suppliers continue to benefit from aircraft production demand and a backlog of maintenance orders; at the same time, defense manufacturers also have business opportunities related to missiles, shipbuilding, and military modernization. However, market expectations for some companies are already elevated, future government spending is uncertain, and slowing air passenger traffic growth could all limit investors' willingness to further raise valuation multiples for related stocks. The analyst prefers to focus on two types of companies: those with opportunities for upward earnings revisions, and those whose market expectations are already low enough to have room for a rebound. This strategy means that in commercial aerospace, JP Morgan favors Howmet Aerospace and Honeywell Aerospace; in defense, it prefers Lockheed Martin and Huntington Ingalls Industries. By contrast, government services providers such as Leidos still face a more difficult path to recovery. Howmet Aerospace and Honeywell Aerospace offer investment opportunities in aerospace Despite market concerns about changes in the aircraft engine supply chain, JP Morgan remains bullish on Howmet Aerospace. Howmet Aerospace's stock price has been under pressure, partly due to GE Aerospace's (GE.US) plan to acquire Consolidated Precision Products, while another supplier is also developing blade casting capabilities. These developments have raised questions about Howmet Aerospace's long-term competitive position in aerospace castings. The analyst expects Howmet Aerospace's 2026 earnings forecasts to be revised upward and expects management to remain confident about growth prospects in aerospace and industrial gas turbine businesses. The analyst also believes Honeywell Aerospace's stock price could rebound. Since the company reported second-quarter results, its stock price has fallen more than 25%, while the Industrial Select Sector SPDR Fund (XLI) fell only about 10% over the same period. Although Honeywell Aerospace faces long-term challenges, JP Morgan believes market expectations have been sufficiently lowered, so as long as the company does not miss expectations, the downside for the stock price may be limited. Meanwhile, TransDigm Group (TDG.US) may benefit from stronger-than-expected preliminary fiscal 2027 guidance. JP Morgan expects aviation aftermarket demand to remain healthy despite concerns about slowing air passenger traffic growth and possible changes to aircraft maintenance regulations. The bank warned that if global air passenger traffic stagnates for a prolonged period, it could eventually weaken maintenance demand. However, the current backlog of engine maintenance work should continue to support aerospace aftermarket suppliers in the coming quarters. U.S. midterm elections cloud the outlook for defense spending The congressional elections in November are another potential source of volatility for defense contractors. Since March, U.S. defense stocks have been under pressure as investors assess whether control of Congress could change and whether such a change would limit growth in military spending. The analyst said some election-related uncertainty may gradually dissipate after voting ends on November 3, but negotiations over the fiscal 2027 federal budget could continue long after Election Day. The analyst also noted that rising government borrowing costs are a factor requiring long-term attention, as there could be competition for funds between interest expenses and discretionary defense spending. For investors, the timing of appropriations arrangements and contract awards may be just as important as the final size of the defense budget. In defense, favoring Lockheed Martin and Huntington Ingalls Industries JP Morgan listed Lockheed Martin and Huntington Ingalls Industries as its preferred defense stocks ahead of third-quarter earnings, even though both currently carry "Neutral" ratings. For Lockheed Martin, Morgan Stanley expects the company to continue improving execution and benefit from a sharp increase in backlog driven by missile contracts. The analyst said the company's missiles and fire control business remains an important factor attracting investors. Huntington Ingalls Industries may benefit from progress on major shipbuilding programs, including milestones related to the aircraft carrier John F. Kennedy (CVN-79) and a submarine contract awarded in July. The analyst believes these developments support market expectations for the company's profitability and cash flow for the remainder of 2026. Since its most recent earnings report, Huntington Ingalls Industries' stock price has fallen about 20%; by comparison, Lockheed Martin fell 13%, and Northrop Grumman Corp. (NOC.US) fell 12%. This may create room for share prices to react positively to good news. In addition, JP Morgan is more cautious on Northrop Grumman Corp. because the company benefits relatively less from missile demand and lost the competition for the U.S. Navy's F/A-XX next-generation carrier-based fighter program. Earnings outlook weakens, Leidos downgraded JP Morgan cut its price target on Leidos from $160 to $142, reflecting the bank's concerns about the company's health business and the risk of further disappointing results. The new price target is still about 25% above Leidos' closing price of $113.55 on October 7. However, the analyst believes that although the company's valuation is relatively low, that is not enough to support an "Overweight" rating, especially when other aerospace and defense stocks also offer considerable potential returns. JP Morgan expects Leidos' 2027 revenue to be about $18.1 billion, down from an estimated $18.35 billion in 2026; adjusted EBITDA is expected to fall from $2.45 billion to $2.14 billion. The analyst noted that consensus expectations still forecast Leidos' 2027 adjusted EBITDA at about $2.45 billion, suggesting that published market earnings expectations may be too optimistic. The bank also expects Leidos' adjusted EBITDA margin to fall from 13.3% to 11.8%, mainly due to weakness in its health businessthe margin for that segment is expected to drop from 22% to 16%. Nevertheless, Leidos still has potential growth opportunities in defense products, energy infrastructure, and Federal Aviation Administration (FAA) modernization projects. If the company achieves a favorable outcome in the recompete for the U.S. Department of Veterans Affairs contract, its business outlook could also improve. Cash flow concerns remain, Boeing Company still rated "Overweight" JP Morgan maintained its "Overweight" rating and $290 price target on Boeing Company (BA.US). The price target is about 54% above Boeing Company's closing price of $188.32 on October 7. The bank continues to believe Boeing Company can increase production of the 737 and 787 aircraft, advance the delayed 777X program, and stabilize performance in its defense business. However, the analyst also acknowledged that market expectations for Boeing Company's 2027 cash flow have weakened, and uncertainty over the aircraft production outlook has added to investor caution. JP Morgan expects Boeing Company's 2027 revenue to rise from $96.31 billion in 2026 to $108.46 billion; adjusted free cash flow is expected to increase from $1.84 billion to about $5.55 billion. The bank's long-term investment thesis depends on whether Boeing Company can convert its backlog of about $500 billion into actual aircraft deliveries, thereby improving cash generation and reducing debt levels. JP Morgan also maintained its "Overweight" rating and $40 price target on StandardAero (SARO.US), citing growth opportunities in both commercial aircraft engine maintenance and higher-margin component repair services.