The commercial aerospace sector has been hit hard by the COVID-19 pandemic, with airlines that just a few months ago were in expansion mode now doing everything they can to cut costs and raise liquidity. That means fewer planes in the air, fewer spare parts needed, and ultimately fewer new jets ordered for the foreseeable future.
As a result, shares of leading plane manufacturers Boeing (BA 0.01%) and Airbus (EADSY -0.28%) have lost more than half of their value so far in 2020, and their suppliers have not done much better. Boeing predicts it will take years before aircraft demand recovers, so it's bringing down production rates.
Even after those steep share price declines, I can't recommend buying Boeing or Airbus right now. But for those with a long enough time horizon who want to buy into their sector while prices are low, there are options. Here are three commercial aerospace-focused companies worthy of your consideration today.
Heico: Diversification will help it recover quicker
Heico (HEI -0.45%) is best known as a maker of aerospace avionics, components, and spare parts, but it derives about half of its revenue from activities outside of the commercial aerospace sector.
The company makes parts that go into medical equipment such as ventilators, X-ray systems, sterilization equipment, and personal protective equipment. Its defense business has held up well of late, and with the Pentagon committed to keeping supply chains up and running, it shouldn't see the sort of falloff in demand that the company's commercial
aerospace segment has endured.
Image source: Getty Images.
Heico's certainly going to take a hit as airlines downsize, and some of that defense and non-aerospace revenue could tail off in the event of a recession, or if the government cuts Pentagon spending to help pay for emergency economic stimulus. The company could also see supply-chain disruptions if a second wave of COVID-19 causes new closures of nonessential businesses and stay-at-home mandates.
However, Heico's commercial aerospace business looks like a good bet to recover faster than Boeing due to its emphasis on aftermarket sales of replacement parts instead of new planes. When airlines do eventually ramp up operations again, they are likely to do it with jets already in their fleets instead of committing to expensive new airplane purchases. Low oil prices make that decision easier since much of the cost benefit to a new jet is its fuel efficiency.
Aftermarket sales accounted for 54% of Heico's total 2019 flight support revenue, and repair and overhaul services accounted for another 24%. It seems likely those sales will begin to rebound as soon as airlines start restoring flights and should recover much faster than new plane sales do. Add it all up and Heico, though sure to take a hit from the pandemic, looks like the "cleanest dirty sheet" in commercial aerospace.
TransDigm: Margin master at a discounted price
Heico was the top-performing aerospace stock of the last decade, up 1,280%. TransDigm Group (TDG -1.00%) was the runner-up, with a 1,084% gain, and the two companies' similarities go far beyond their stock performances.
TransDigm, too, relies on aftermarket sales for the bulk of its revenue and earnings. On an early May call with investors, company executives said they were assuming aftermarket revenue would decline by 70% to 80% for the next six months, but said they hoped that estimate ends up being conservative.
This company has been a top buy because of its ability to generate software-like margins of 40% or higher on industrial goods. TransDigm has accomplished that feat over the years by buying up businesses that make proprietary or hard-to-replicate parts.
Image source: Getty Images.
Management believes its margins are sustainable even through the downturn, as nearly 80% of TransDigm's cost footprint is variable, meaning the company has flexibility to adjust spending based on demand. About half of TransDigm's spending is on inputs, either raw materials or payments to subcontractors, and another one-third is tied to labor.
TransDigm does have a few potential worries that make Heico a better buy right now. It doesn't have the healthcare or other non-aerospace revenue that Heico has -- it generates about 65% of its sales from commercial and the rest tied to defense. It also tends to get some of its best profit margins from parts used on the oldest planes, which are also the planes most likely to be retired from airlines' fleets permanently.
But even if TransDigm does take longer to recover than Heico, the stock is also down 42% year to date, 15 percentage points further than Heico. Investors who buy in at these levels are likely to be well-rewarded over time.
Raytheon Technologies: Focused on defense
Raytheon Technologies (RTX -0.04%) was formed on April 3 when United Technologies merged its aerospace assets with defense contractor Raytheon. The deal was sold to investors as a way to balance the portfolio, combining UTX's commercial aerospace-heavy business with Raytheon's defense assets. Management could have never imagined at the time how quickly that diversification would be needed to help steady the ship.
As a defense contractor, Raytheon Technologies will likely be dragged down by the commercial business for some time, and for now is not a defense best buy. But there is great long-term potential in the commercial assets, and the defense business should alleviate investor concerns about the company's ability to survive the downturn.
On the defense side, Raytheon is a maker of missiles, sensors, and specialized electronics, while its commercial portfolio includes Pratt & Whitney engines and Collins aircraft interiors.
United Technologies shares had lost about 40% of their value year to date prior to the merger, and the company will take a substantial hit due to the pandemic. Raytheon Technologies on May 7 said it plans to cut about $2 billion in costs on the commercial side and take other actions to conserve about $4 billion in cash -- management predicts it will be two years or more before we see a recovery.
On the defense side, first-quarter orders came in at a pace 1.44 times higher than what went out the door, helping swell the defense backlog to more than $70 billion. Raytheon is a leader in missiles, recently winning a high-profile government award that could be worth $10 billion.
Even if its commercial aerospace segment is a drag on earnings and the share price for now, Raytheon Tech investors will be well compensated for their patience. At current prices, stock's dividend yields more than 4%. And, during that May 7 post-earnings call, CEO Greg Hayes told investors the company remains committed to the dividend, "and we have sufficient cash and liquidity to maintain a competitive dividend even in this very difficult environment."
