Over the past three years, much of the total shareholder return in the aerospace and defense sector has come from multiple expansion, which leads to a growing need for portfolio reshaping to justify the high multiples. Jim Wininger, a partner with Bain's Aerospace, Defense & Government Services practice, describes the five characteristics of successful portfolio reshapers.
Read the transcript below.
JIM WININGER: Today, A&D stocks are priced for perfection. In the 9/11 era, the sector traded at between 8 and 12 times pretax earnings. Whereas today, it's averaging 14 times. And over the last three years, 70% of the total shareholder returns in the sector have come from multiple expansion.
That means there's a profound need to drive operating profit growth to justify those multiples. And that's challenging in today's environment when commercial deliveries and backlogs are at all-time highs and the defense market outlook, while improving, is not sufficient to justify such exuberant multiples.
So we believe that the right path for many companies in the sector is to take a deep look at their portfolio and reshape it in order to drive better, stronger leadership positions and add new capabilities for future growth. And the five characteristics of successful portfolio shapers are, first, taking a market-driven view of their business definition -- so common customers, common cost structure, and common competitors, not viewing the world through the lens of historical org charts.
Second, they take a clear-eyed view of the potential and the current performance of those businesses. And third, they allocate scarce resources, talent, and capital undemocratically, rather than peanut buttering it across the whole portfolio. Fourth, they take a view of both sides of the coin, what to buy and also what to sell, in order to generate capital to reinvest behind those leadership positions.
And finally, they sequence these actions into a coherent plan versus trying to do everything at once. We believe that high multiples today should spur A&D companies into action, and that those who don't may be faced with fewer options or overvalued portfolios and no way to justify their high multiples.
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Companies that are successful in portfolio shaping tend to follow five rules.