The COVID-19 pandemic has hit the aerospace industry hard in 2020. The industry started the year as the star performer in an otherwise weak industrial economy. However, it will end it with investors wondering just when commercial air travel can get back to 2019 levels and what kind of industry it will be in the future? In order to shed some light on these questions, let's take a look at what Raytheon Technologies (NYSE:RTX) CEO Greg Hayes has said recently about the industry.
It's going to be a slow recovery
It's no secret that it's going to take years for the industry to recover, and the timing of the recovery is important. After all, analysts and investors will be penciling in earnings assumptions based on when air travel will get back to previous levels. A slowdown in air travel impacts both original equipment manufacturer (OEM) sales and the aftermarket -- both key areas for engine manufacturers Raytheon and General Electric (NYSE:GE).
In this regard, the medium-term outlook appears to be worsening. For example, back in May, Hayes discussed the aftermarket during the earnings call and implied he was "assuming a 2- or even a 3-year kind of recovery here." Fast forward to a July interview with Aviation Week and Hayes said, " I would say we're looking now at getting back to 2019 in 2023, maybe 2024. It is going to be a slow recovery."
Unfortunately, it appears the outlook is deteriorating, and that may explain the recent weakness in the sector.
Narrow-body over wide-body
During the Aviation Week interview, Hayes also raised the prospect of a bifurcation in the recovery for narrow-body and wide-body aircraft. The former is seen as recovering quicker as it's "primary domestic," according to Hayes. Meanwhile, wide-body aircraft are more reliant on international and intercontinental travel -- markets seen as recovering more slowly.
If Hayes is right, then it's not good news for General Electric and Boeing (NYSE:BA). Boeing was previously hopeful of a cyclical pickup in wide-body orders beginning in 2020 and inspired by the new 777X and ongoing demand for the 787. Meanwhile, GE is impacted because its GEnx engine is one of the two options on the 787, and its GE9X is being developed for the 777X. Indeed, Boeing is already cutting production of its wide-body aircraft.
Defense spending will get selective
Given the current commercial air-travel environment, it's not surprising that aerospace investors have been willing to pay a premium for companies in the closely related defense sector. However, Hayes made it clear that " Defense budgets will go down, but I think the real question is where Defense Department spending is going."
Hayes sees Raytheon as relatively well placed given its exposure to cyber protection, intelligence, communications, and electronic warfare. However, questions might be asked about companies with exposure to traditional military hardware like General Dynamics.
What it means for the leading players
If Hayes is right, then investors should feel a bit more negative around the outlook for all the leading aviation companies. After all, no one wants to see the timeline of a recovery in commercial air travel being pushed out.
However, it's clear that Boeing and GE are set to be net losers if wide-body demand doesn't recover, particularly as it's an area where Boeing is seen as having an edge over Airbus, and GE over Raytheon. It increases the pressure on cash flow at Boeing. Meanwhile, GE's cash flow is heavily reliant on its aviation segment, and it's invested heavily in the GE9X engine for the 777X in the hope of years of lucrative aftermarket revenue to come.
Turning to Raytheon, the tardiness of a commercial aerospace recovery is obviously a concern for its aircraft engines, but its defense business looks well placed and will support the commercial business through a difficult time. Management expects $2 billion in free cash flow for 2020 as Raytheon absorbs the bulk of the COVID-19 hit. Analysts have that bouncing to something near $6 billion in 2021. Given the current market cap of $91.6 billion and the prospects of an ongoing recovery thereafter, Raytheon looks a good value stock right now.