Aerospace and Defense
All About Aerospace/Defense -- 2009
Aerospace/Defense
Joseph B. Nadol IIIAC
(1-212) 622-6548
joseph.nadol@jpmorgan.com
Seth M. Seifman, CFA
(1-212) 622-5597
seth.m.seifman@jpmorgan.com
J.P. Morgan Securities Inc.
See page 87 for analyst certification and important disclosures.
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• Defense spending should hold up near term, but long-term outlook tougher. We
expect double-digit investment account outlay growth in FY09, and a solid FY10
looks increasingly secure, but defense spending faces a two-front battle that could
result in a downturn starting in FY11. First, supplemental budgets should be down
in FY09, and with more troops coming out of Iraq we expect them to fall further in
future years. Second, the base budget should face pressure due to ballooning federal
deficits. Washington appears to be taking a pass on fiscal discipline in FY10, but the
budget will probably face belt tightening when deficits matter again, potentially in
FY11. Steady cash flows and strong balance sheets mean defense stocks still could
perform relatively well in early 09, but the budget picture presents a fundamental
challenge and defense should underperform in a market recovery.
• Commercial aero is in for a tough year, but long run looks brighter. Commercial
aero stocks were battered in 08, with valuations that were hard to ignore at times, but
we believe it is still early to turn bullish with so much bad news on the horizon.
Global air traffic should decline in the first half of this year, and we believe deferrals
driven by lower demand and financing challenges will cause narrowbody production
rates to be cut by the end of the year. We are looking for smaller production rate cuts
than past cycles, but margins should come under significant pressure. Suppliers will
face a challenging aftermarket environment given declining aircraft utilization. As a
result, downward earnings revisions seem likely throughout the year. However, we
see more upside potential for commercial aerospace stocks than defense stocks in the
coming years, as the global economy will bounce back, and huge barriers to entry
will provide these companies with major opportunities.
• The 787 development schedule seems likely to reach an inflection point. One
place we see potential for good news in 09 is on the 787 program. Boeing seems to
be working past fastener and systems integration problems that have been hindering
progress, and with the machinist strike now out of the way, the path toward first
flight looks clearer. If Boeing reaches this milestone in Q2, we would view it as a
major positive for aerospace stocks in an otherwise difficult year, and this is one
reason we favor PCP and COL among aerospace stocks.

Table of Contents
Investment Thesis ....................................................................3
Commercial Aerospace................................................................................................3
Defense ........................................................................................................................3
Key Investment Points .............................................................4
We highlight our top industry predictions for the next twelve months........................4
Commercial Aircraft Cycle Outlook ......................................10
Stocks Historically Have Followed Orders, Which Should Be at a Far Lower Level
for Several Years .......................................................................................................21
Earnings Downturn Led by Margins .....................................24
Some Companies Should Fare Better Than Others....................................................24
Aircraft Development Programs............................................28
787: Can It Finally Turn the Corner in 2009?............................................................28
A350: Demand Still Relatively Strong, But Development Questions Remain ..........30
A380: Production Ramping Up..................................................................................32
747-8: A Great Freighter, But Can the Passenger Variant Compete? ........................33
Narrowbodies: Multivariable Calculus ......................................................................34
Aircraft Finance: Tough Times in 2009.................................37
Regional Aircraft Outlook ......................................................42
Subject to the Same Cycle .........................................................................................42
Business Jet Outlook: Pain After the Pop............................46
China: A Long-Term Growth Driver ......................................50
Large Commercial Jets: Near-Term Pressure, But No Order Bubble ........................50
Regional Jets Are Highly Underrepresented..............................................................52
Business Jet Fleet Should Multiply Over Years.........................................................53
Defense Outlook.....................................................................55
Good Visibility for Solid Near-Term Performance, but Fundamental Challenges
Approaching...............................................................................................................55
Who Wins and Who Loses from Declining Supplementals? .....................................58
What Will Change in the Obama Administration? ...............61
Tough Choices Lie Ahead .........................................................................................63
Large-Cap Organic Growth Should Remain Mid Single Digit
.................................................................................................68
Defense Margins Could Be Topping Out..............................75
Pension Should Drag on 09 Earnings ........................................................................77
Capital Deployment................................................................78
Returning Cash to Shareholders Remains Top Priority .............................................79
Mergers and Acquisitions ..........................................................................................83