Rankings of publicly traded aerospace and defense contractors are the result of a composite scoring of four equally weighted performance categories that place significant emphasis on operating excellence. Category weightings are based on results of two surveys conducted by Aviation Week with senior management of companies generating annual revenues greater than $1 billion.
The four categories are:
Return on Invested Capital (ROIC), measuring net profitability (NOPAT) to average capital investment. It is a widely used asset utilization metric used to evaluate a company’s investment decisions. AW&ST’s computation rewards companies with superior top-line profitability (referred to as “operating profit”). Non-operating income and/or expense, discontinued operations, extraordinary and special items are not considered. Goodwill is included in the capital base.
Earnings Momentum, offering a string of metrics measuring year-over-year earnings momentum, earnings quality and revenue expansion that evaluate company decisions to adjust plant capacity, lower unit costs and/or increase sales at rates ahead of the accompanying rise in direct production costs. Non-operating income and/or expense, discontinued operations, extraordinary and special items have not been considered in the calculation of metrics using cash flow (EBITDA) components. EBITDA stands for earnings before interest, taxes, depreciation and amoritization.
Asset Management, representing the composite result of a series of industry turn-rates that measure how efficiently a company employs its resources using comparisons of revenue to total assets, inventory, working capital and receivables. Government and/or third party-owned inventory and other productive assets are not considered in these computations.
Financial Health, representing the composite result of a string of metrics measuring a company's financial strength, including an overall solvency assessment, liquidity available to fund current operating requirements and debt coverage. Cash flow-related calculations do not consider non-operating income and/or expense, discontinued operations, extraordinary gains and/or losses and special items.
Four groups were ranked by revenue this year, including companies with revenues (1) greater than $20 billion, (2) between $5-$20 billion, (3) between $1-$5 billion and (4) $250 million-$1 billion.
Scoring Algorithms Assigned to Companies Based on Revenues
To accommodate differences in operating profiles, separate scoring algorithms were applied to companies falling into one of the four groups according to fiscal 2013 revenues.
Ratios Selected From Regression Procedure
The scoring algorithms used to rank this year’s Top-Performing Companies were last revised for FY2009 results. They were compiled from an initial sampling of test ratios assigned to the four performance categories. Test ratios were calculated for most companies surveyed in the study over a 12-year period (1998-2009) and subjected to an extensive compilation that generated preliminary values for total score. Preliminary results were then analyzed using a regression procedure that identified test ratios most closely supporting the preliminary values. Those ratios were selected to build the scoring algorithms that generated the rankings. All ratios have been collared to eliminate outlier results.
Calculations are based on the latest operating results reported for fiscal years ended no later than Dec. 31, 2013. Mark-to-market asset impairment write-downs, gains/losses from currency-related derivatives, non-operating transactions, discontinued operations, extraordinary gains and/or losses and special items have been excluded from all cash flow-related computations to normalize current and prior years’ results.
Where possible, companies with fiscal year-ends prior to Dec. 31 have been scored, using interim quarterly data, to the calendar year-end to better match operating performance between companies.
For non-U.S. companies, income statement data presented in native currencies have been converted to U.S. dollars on an averaged, trailing four-quarter basis. Balance sheet data have been adjusted to year-end currency conversion rates and prior years restated, where applicable.
To be included in this survey, companies had to derive at least 30% of revenues from the aerospace and defense sector and have direct and/or indirect state ownership less than 50%.
Further Review Opportunity Gained From Methodology Design
In addition to facilitating company rankings, total score and results shown in the tables for the four performance categories can also be interpreted as percentiles of performance for FY2013 compared to peer results over the 12-year sample period. A score of 85, for example, indicates that a company’s performance is within 14 points of the best result earned by a company in its peer group during the 1998-2009 period.
BUSINESS SEGMENT RESULTS
Business segment scoring accompanies TPC survey results.
This year’s rankings include 111 stand-alone or combined company operating units (sharing the same category) with fiscal year revenue greater than $500 million, grouped into 15 operating categories comprising:
- Military Aircraft
- Commercial Aircraft
- Business Aircraft
- Avionics/Flight Management/Control Systems
- Civil & Military Training & Support Services
- Forgings/Castings/Precision Components
- Information Technology Services
- Land Systems
- Naval Systems
- Missile & Weapons Systems
- Radars/Sensors/Electronic Warfare/C4ISR
- Space Systems
Multiple A&D business segments nested in a single operating category and sourced from a single company are scored on a combined basis. They are presented in blue.
This year’s TPC business segment universe includes stand-alone A&D operating units, multiple segments nested in a single operating category that have been scored on a combined basis and non-A&D units (presented as supplemental information in the company performance sheets).
Except for those operating units assigned to Information Technology Services (“IT”), scored results can be compared across the other 14 categories. Three scoring algorithms were compiled for this study. Metrics for each were built from data extracted from parent company footnote disclosures.
Certain large U.S. companies with a high concentration of government contracts subject to federally mandated Cost Accounting Standards (CAS) report business segment footnote data on the more favorable CAS versus GAAP/IAS accounting basis. Since the CAS benefit is currently disclosed in an aggregate amount not allocated to specific business units, unit calculations exclude any adjustments that would conform segment data to the parent company’s GAAP-based operating results and financial position.
Where possible, business unit interim results prior to Dec. 31 have been scored, using quarterly data, to the date corresponding to the parent company’s TPC-score. Where applicable, prior year data and scores have been restated.
The three scoring algorithms include:
- Primary Algorithm (“Primary”), scoring over 80% of the total units presented. Metrics used in this algorithm, if applied to the consolidated P&L and balance sheet results of non-IT companies, are 80% correlated to parent TPC scores based on a 12-year (1999-2010) look-back period.
- Limited Algorithm, scoring approximately 5% of total units presented, is utilized when segment disclosures include only revenue and operating profit data. Correlation of metrics used in this algorithm to parent results of non-IT companies and their corresponding TPC scores over the Primary test period is 74%.
- IT Algorithm, scoring 20 segments and qualifying companies that have a heavy concentration of A&D-related government contracting. This algorithm was developed to accommodate the unique nature of the IT business model compared to other A&D operating units. Correlation of IT metrics to parent results and earned TPC scores over the primary test period is 72%.
Business segment scores across all categories (except IT) have been adjusted to present relative values ranging from 1.0 (worst performance) to 99.0 (best result) over a two-year sample period (2009-2010). Because of this arithmetical transformation and construction of the scoring algorithms that were not specifically aligned with TPC-defined peer groups, business segment scores will not necessarily correspond or provide a meaningful comparison to parent company TPC results.
OTHER OPERATING BENCHMARKS
Quality of Earnings-Advanced DuPont Model
Return on Equity (ROE) measures the profitability of a company’s business. The Advanced DuPont Model defines the percentage contribution of the ROE result from operating and/or debt (financial leverage) sources.
BUSINESS MODEL PERFORMANCE
Economic Profit measures value created in excess of the aggregate of required returns to company investors (including shareholders and lenders).
Return On Sales (ROS)
ROS evaluates a company’s operational efficiency by calculating net income before net gains and/or losses from discontinued operations, divided by revenues.
The Top-Performing Companies methodologies were developed and implemented by Michael K. Lowry, who acted as project manager for this study. Lowry is a former senior executive at aerospace and airlines companies and an equity analyst.
Raw information for TPC results was provided by Standard & Poor’s utilizing its Capital IQ database application.