Why You Should Buy Aerospace Stocks on Weakness in 2021

The aerospace sector finds itself going into a highly unusual period as it enters 2021. On the one hand, investors in the industry should definitely brace themselves for some near-term weakness. On the other, any overly negative reaction to the news flow and earnings reports in the coming months should be regarded as a potential buying opportunity in the higher quality names like Raytheon Technologies (RTX 0.84%) or Honeywell (HON 1.66%). Here's why.

Near-term weakness

There's no way to sugarcoat this. The recovery in commercial aviation has been weaker than most industry observers hoped and predicted it would be in 2020. For example, the International Air Transport Association (IATA) has progressively increased its estimates for worldwide airline losses for 2020 and 2021 as the current year has progressed.

Data source: IATA presentations.

The IATA's forecasts match up with trends in commercial flights which hit a plateau in August, and despite significant regional differences, haven't recovered on a global basis since then. In terms of flights in 2020 compared to 2019 through the fourth quarter, an improvement in China has been offset by declines in Europe, while the US has reached a plateau in line with the global figures.

Data source: Radarbox.com, author's analysis.

In short, it's not good news for the industry, and it suggests that aerospace company earnings will be pressured in the fourth quarter. If aircraft aren't flying, then they won't be serviced as much, which is bad news for the aftermarket sales for companies like Raytheon, Honeywell, and General Electric. Also, if aircraft aren't flying, then airlines will lose money and aircraft orders will suffer. The consequences of this dynamic will flow through the whole industry starting with Boeing and Airbus and ending up in the original equipment sales of Raytheon and Honeywell.

So don't be surprised if aerospace companies start reporting disappointing results in the coming months.

Why it might create a buying opportunity in 2021

Nevertheless, investors in the industry shouldn't panic, and any significant weakness should be seen as creating a potential buying opportunity. There are two main reasons for this. First, the rollout of the vaccine will accelerate the ongoing process of the development of herd immunity. The implication is that people will feel a lot more comfortable getting on a plane if they have immunity from the virus and/or infection rates are dropping.  That much is well known, but the second point is more subtle.

Specifically, there's reason to believe that travelers will seek to return to the air given the right conditions. This is a key debating point because some of the bears believe that business travelers and the general public will hold off air travel for an extended period.

Image source: Getty Images.

China and the global business jet market

It's clear from the first chart above that air travel is coming back in China. In fact, domestic flights in China in 2020 have been in year-over-year growth mode since September. If China's population is representative of the globe, at least in terms of air travel, then it's likely that worldwide air travel will recover when conditions around the COVID-19 pandemic improve too.

Furthermore, business jet flights came back strongly in 2020, and the latest data on business jet flights in Europe are actually showing positive growth on a year-over-year basis. It's a clear indication that there's underlying demand coming from business travelers in Europe even if they are unable to use commercial air flights. Similarly, the data on US domestic business jet flights are indicating an ongoing recovery.

Moreover, the worldwide numbers in the fourth quarter are in line with Honeywell's Global Business Aviation Outlook. Honeywell, a company with relatively high business-aviation exposure (around a third of its total aviation sales), is forecasting that business jet traffic will be at 2019 levels by the summer of 2021. In other words, an ongoing recovery looks likely.

That would be good news for a company like Raytheon Technologies that offers investors a mix of downside protection thanks to its defense-related revenue and upside promise from its commercial aerospace businesses. 

Data source: radarbox.com, author's analysis.

Stocks to buy?

The commercial flight data have been disappointing in the fourth quarter and particularly so for Europe. Obviously, this is a consequence of travel restrictions put in place following a resurgence of COID-19 cases in Europe and elsewhere. There's little that airlines can do about this, so don't be surprised if the aerospace sector starts reporting weak results. 

However, investors in stocks like Honeywell and Raytheon shouldn't get too despondent if there's a dip in the first calendar quarter of 2021. After all, stocks are bought for their long-term earnings and cash flow. Demand for Raytheon's components/engines and aftermarket parts and Honeywell's aerospace components will improve in the future provided  conditions around the pandemic improve in 2021. As such, there's a strong argument for buying into both stocks on any significant dip.