The reasons for liking commercial aerospace, or constituents involved in the production of commercial aircraft, are many and varied. The liberalization of air travel between global point-to-point markets has facilitated expansion in not only leisure travel but also business travel between countries. The advent of the low-cost-carrier model in the likes of Southwest (LUV) and others just like it around the globe has made air travel affordable to those that it once had “priced out.” The growing middle class in developing countries has paved the foundation for continued passenger growth, something that should be expected for decades to come. The collapse in jet fuel costs has made the global airline industry, or those involved in the transporting of people from point A to point B, more economically profitable than perhaps any other time before it.
We’ve long liked the tailwinds benefiting constituents in the commercial aerospace supply chain. Warren Buffett and his team at Berkshire Hathaway (BRK.A, BRK.B), however, has complicated a few things for us with his brilliant move in scooping up one of our favorite aerospace suppliers, Precision Castparts (PCP). The problem with such a transaction for us is that Precision Castparts has been our “go-to” publicly-traded aerospace equity. The metal bender makes critical engine castings and airfoils, has among the best customer relationships around, as efficient manufacturing processes as we’ve ever seen, and a management team that integrates acquisitions like no other, as it aggressively attacks costs in every aspect of the business. The team at Precision Castparts is spectacular, and frankly, we were a bit sad to see the Oracle of Omaha gobble up shares. There are other aerospace suppliers we like, including Astronics (ATRO) and Rockwell Collins (COL), but not as much as Precision Castparts.
A few threats have entered the fray regarding the magnitude and duration of the ongoing strength in commercial aircraft deliveries, not the least of which is economic weakness in Asia, a key source of airplane demand, and recent comments by Delta (DAL) that a “bubble” in the wide-body market is brewing. We think both concerns have merit, but the magnitude of the backlogs of unfulfilled commercial aircraft deliveries at Boeing (BA) and Airbus (EADSY) are incredible, accounting for several times annual run-rate revenue. Boeing noted in its third-quarter results, released October 21, that its total backlog for commercial airplanes stood at $426 billion, nearly 6.5 times its target annual revenue from commercial airplane activities in 2015, ~$66 billion. The runway for commercial aerospace demand is long, in our view, and Boeing’s results continue to speak to such strength.
Industrial bellwether, General Electric (GE), a holding in both Valuentum newsletter portfolios, continues to execute well within the aerospace arena, revealing GEnx new wins with Quantas and CIT Aerospace and a services agreement with Southwest during the third quarter, results released October 16. The industrial giant’s ‘Aviation’ division remains a key source of strength, with revenue in the segment expanding 5% and divisional profit leaping 7% in the quarter. Perhaps what we like most about GE’s aerospace operations is not only that it continues to gain scale within engine and turbine applications, but that its installed base offers a nearly impossible-to-replicate customer “stickiness” and its services-focus adds to an overall lucrative, high-margin proposition. We’re looking forward to seeing what GE can do in aerospace once the anchor of its financial operations is lifted, and we won’t be participating in the Synchrony (SYF) share exchange. We’re generally risk-averse when it comes to financials exposure.
Honeywell (HON) and United Technologies (UTX) offer additional insight into the health of the commercial aerospace market. The former achieved modest organic sales growth in its ‘Aerospace’ segment during the third quarter, results released October 16. Strength in ‘Business and General Aviation (BGA)’ engine shipments was notable, while ‘Commercial Aftermarket’ sales advanced 3% on a core organic basis thanks to ongoing repair and overhaul requests. Honeywell’s ‘Aerospace’ segment profit advanced 5% during the period, a solid showing at this point during the economic cycle. United Technologies continues to restructure its business, selling Sikorski Aircraft to Lockheed (LMT), but performance at Pratt & Whitney was solid in the third quarter, results released October 20, with organic revenue advancing 8% in the division. Organic sales at UTC Aerospace edged up modestly during the period.
Our existing preferred way to gain exposure to commercial aerospace is through the supply chain, and General Electric remains our top pick for that, but we like others in the supply chain, too, including both Honeywell and United Technologies on a fundamental level, the latter offering an interesting valuation opportunity for patient investors. For investors that are looking for broad exposure, the iShares US Aerospace & Defense ETF (ITA) presents a consideration, as it weights Boeing and United Technologies as the top two holdings at nearly 17% of the ETF on a collective basis. As with its peers, the PowerShares Aerospace & Defense Portfolio (PPA) and the SPDR S&P Aerospace & Defense ETF (XAR), however, the ETF has defense exposure, which may not be of preference.