Just How Cyclical Is the Aviation Business?

If you're invested in airplane manufacturers, then you likely know how highly cyclical the industry is. What should you be looking for to make sure that the business is still healthy, or even decide that it might be time to exit the investment altogether? Blake Bos talks with Stock Advisor senior analyst Jim Mueller about two metrics to follow so you can get out at the right time.

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Blake Bos: Blake Bos here, folks. Today we're going to be talking aviation. I'm here with Jim Mueller. He's a senior analyst on our Stock Advisor newsletter here at The Motley Fool. Today I want to talk about the commercial aviation market. You know, as an investor, I look at statistics like a $4.8 trillion demand for aircraft, going into 2032.

I'm like, "I'd like a piece of that," but when I look at Boeing (NYSE: BA  ) from day to day, I'm kind of worried. Is it really cyclical? Am I going to invest in this and I'm at the market top, and I'm going to lose out as soon as Wall Street knows more than I do and gets out, and I'm just sitting around?

As an investor, when I look at aviation, is there any way I can tell when the cycle is, or is there a cycle, or do I just hold on forever? What's your strategy, Jim?

Jim Mueller: Well, I wouldn't hold on forever, but your question is a good one, especially with Boeing up 70%-80% so far this year, or over the past year. It's been quite a ride.

It is cyclical to the extent that the commercial aviation business is tied to the economy and the number of passengers flying, which dictates demand from the airlines for ordering new planes. Boeing itself also has a big defense arm, so they're cushioned a bit from the ups and downs that airlines might see, for instance.

But as far as commercial aviation goes, I would look at their backlog and make sure it continues to grow, and also be aware of whether some of the backlog of those that are placed by the airlines can be canceled, and under what conditions. During the great recession, airlines were canceling orders, and Boeing was suffering because of that.

I'd also look at the book-to-bill. That is, are the new orders coming in faster than the revenue that is being produced by those orders? That'll tell you whether revenue will continue to grow. If that starts tipping down below a ratio of one, then you might consider it might be time to start thinking of getting out.

Bos: Book-to-bill means somebody orders an airplane...

Mueller: Right, they book the order.

Bos: They book the order.

Mueller: Maybe it's a $100 billion order. Then if Boeing produces $90 billion in revenue that period, then the book-to-bill would be 1.1.

Bos: A little over one. You want to see that over one.

Mueller: You want to see that over one, so that the revenue will always be catching up to the new orders. That gives you an idea of revenue growth into the future.

Bos: Yeah, because if it's below one, revenue's going to shrink going forward because they don't have the orders to offset... filling the orders.

Mueller: Right, exactly.

Bos: All right. Thanks, Jim. That's interesting. I was not familiar with that term.

When you're looking at that backlog and you want it to grow, obviously it's not going to grow forever. If I'm an investor and I own Boeing (hypothetically -- I don't own Boeing right now) and from quarter to quarter I'm looking at the backlog, should I be worried if it dips down one quarter, or should I look at this on a yearly basis?

Mueller: I wouldn't look on a quarterly, because the orders are going to come in clumps.

Bos: Yeah, and they can be really big, too.

Mueller: Right, like the ones that just came out of the...

Bos: 777.

Mueller: Yeah, 777 order. But I would look at the trend over a year and see if that's still growing, and roll your year around the calendar, the last four quarters, and see if that trend is still going up. Also look at the competition, like Airbus EADS (NASDAQOTH: EADSY  ) and even the small airplane manufacturers, because the airlines are buying all kinds of airplanes.

Bos: Yeah, all different types. Maybe you see an industry trend, and if the company is lagging that it might not be a good reason to get out of that particular company. It just might be some weakness there.

OK, Jim, that's some really helpful advice for investors. Book-to-bill, keep an eye on that. Keep an eye on backlog; you want to see it maintaining or increasing over the long term, and try not to focus on quarterly earnings too much. That will get you in trouble. It's always good to take note of those, but you want to look at time periods in year increments.

That's all I have for you today, folks. Thanks for watching, and Fool on!


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