In this episode of Industry Focus: Energy, Motley Fool contributor Lou Whiteman joins the show to break down Jeff Bezos' upcoming trip to space and what it means for other space barons like Elon Musk and Richard Branson. In addition, the podcast takes a look at the state of the defense industry and checks in on Boeing (BA 0.76%) news.
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This video was recorded on June 10, 2021.
Nick Sciple: Welcome to Industry Focus, I'm Nick Sciple. This week, Lou Whiteman joins me to take a look at Jeff Bezos' upcoming trip to space, check in on defense stocks, and more. Lou, great to have you back on the show.
Lou Whiteman: Always a pleasure, Nick. Good to see you.
Sciple: It's been a wild year. Space tourism has been pretty hot ever since Virgin Galactic came public over a year ago; maybe we're looking at two years now at this point. Space was back in the headlines in the past week, Jeff Bezos announcing on Instagram that he and his brother will be among the crew when Blue Origin does its first manned space flight with their New Shepard spacecraft in July. What should we be paying attention to with this story?
Whiteman: On July 20, Jeff Bezos could be launched into space with his brother, July 20 if the weather looks good. This is the tortoise and the hare story. We've heard a lot about SpaceX, obviously. We've heard a lot about Virgin Galactic and Blue Origin. You don't not hear about a Jeff Bezos product, but they've just been meandering along at their own pace, and look out, here they are now. If so, he will beat Richard Branson or he could, we should say. Richard Branson, Virgin Galactic, had hoped to go last summer for his 70th birthday. A lot went wrong with that timetable, COVID gets part of the blame. But partially, this is complicated and you've got to get it right. It looked like Richard Branson would be our first billionaire in space, Jeff Bezos is going to try and jump the line and get up there next month.
Sciple: It's the battle of the billionaires here. I have tweeted about this, who thought Bezos would get into space before Musk. Do you feel like this is a chip on the shoulder for the other billionaires in this game?
Whiteman: I think it is. I think it probably matters to them more than it should to us. To that point, Richard Branson said in one tweet, "This is great, congratulations" and also tweeted, "Hey, I may go on the next test flight in early July." We'll see about that because that will take FAA approval, but yeah. This is a big deal and it does matter. We're talking about it. This is a niche opportunity, hype is going to matter, and it's a very different experience. I think the market may just play out as it does, but this is largely hopes and dreams and hype more than anything, and so it doesn't really matter to me who goes up first, but the fact we're talking about it, the fact that this is creating the buzz, creating the market, it's not insignificant for these guys, either.
Sciple: I think it's worth noting, I think, to fly on Virgin Galactic, it's like a quarter-million dollars to buy a ticket. The addressable market for this really is billionaires fulfilling their childhood dream when we think about who can afford these types of things. It shouldn't really surprise us given the nature of the industry at this point that it's billionaires fighting over who's going to get to space first and probably going to be lots more billionaires before folks like me and you are flying on these spacecrafts. Maybe that goes to the size of the market today, maybe something we wanted to talk about, lots of excitement here. But still, this is a very small market.
Whiteman: This is a small market. I think space tourism, for the time being, is very small, very selective to say, with the ticket prices. Also, it remains to be seen once people do this. I mean, I'm sure it's going to be cool to be weightless for a second, but there was a Wall Street Journal story today or the other day talking about the experience. Most people, when they get zero gravity for the first time, vomit. [laughs] It's not a great thing we talk about in a business podcast, but it remains to be seen if these initial Yelp reviews [laughs] are like, "Wow, I still want to do this." The bigger market right now is these are serious companies trying serious things to get to space, and there is a market for that with commercial launches with NASA. There were limits to this market, but this old-boy network, which was Boeing orbital size which is now owned by Northrop, a couple of players is being disrupted by newcomers, which is both very exciting and very worrisome because it's not a huge market and we're going to have to see how that all plays out.
Sciple: If you're cutting it up into more pieces, then that presents some challenges. I think one of the things that's interesting is we're moving into this commercial space travel universe more and more, assuming Bezos and Branson are successfully able to complete their flights. These are going to be the first paying customers to go on these fights. I guess they paid to start the company, it's not like they're selling outside tickets. But still, this is very new. It's still something that is not regulated by the FAA. I think that'll be a big milestone when we have, this is a mature enough industry that you don't have to sign a waiver to hop on the rocket ship. At what point do you say, "OK, this isn't an emerging industry and this thing is mature?" Are there any signposts we should be looking for?
Whiteman: I think we're in agreement here, and I think you're right. The FAA is actually getting involved, I think that would be the good housekeeping seal of approval. There's still going to be a mass of waiver. These days there's a mass of waivers almost anywhere. Yes, there's going to be waivers, and I think this is one of those businesses that regulation helps, and they're going to come in, so I think that is a sign of maturity. Just the market right now for these guys where they are doing things at cost. When we see how these businesses play out, I'm not sure if Bezos has any desire to take Blue Origin public, but we are going to reach a critical mass where there's actual results, there's an actual business and we're going to see how big it is. It could squanch some of the dreams of investors. They're going to have to invent markets here, and I think the next stage of this is to see how big those markets can be and how successful they are in finding usage for these things.
Sciple: TBD, as you mentioned earlier, one of the places where there is a more meaningful market is in these space launches, working with NASA, working with the government. We've mentioned in the past how the government as your sole customer is an important factor of this business. Well, one business where the government is the sole customer has been doing quite well this year, that's defense stocks. If you look, the defense sector is doing quite well this year. The headline I saw this week is Huntington Ingalls Industries (HII +0.66%), which is one of the largest shipbuilders in the U.S., also the employer of my stepdad, so has a little spot in my heart, hiring 3,000 full-time workers for their shipyards. One of the things we've talked about in the past, as maybe potential flies in the ointment of the defense story is that there has been a significant investment made or allocation made toward enlarging the navy under the previous administration, now with President Biden moving in, some worries that maybe that gets pulled back. Well, when you have one of the nation's largest shipbuilders saying, "Hey, we're hiring 3,000 more workers," that's really showing confidence in a continued robust defense budget. What do you make of the environment for defense stocks and what we can maybe read through from this action by Huntington Ingalls?
Whiteman: Sure. Some context: this is definitely good news, it's 3,000, jobs and it's on the Gulf Coast. It's in the Ingalls' side of it which, Nick, you understand from being from down there, but is the ugly stepchild of Huntington Ingalls, because it's not the nukes that they have in Virginia Beach. This is good news, but I mean, look, Ingalls right now has 11,000 employees. A couple of years ago, almost 13,000. Getting through these last-generation ships that were already baked in before the previous administration talked about growth, those contracts are maturing and to the point where we are getting steady workflow, so I think that explains Ingalls -- that's where they make the destroyer, that's where they make the Coast Guard cutter. I think it's more of a sign of steady work. But your point is a good one. Too much is made of administration year-to-year budget when people consider this sector. What we're seeing with this bounce back off of a terrible 2020, where most of the stocks were down 10% to 30% based largely on the fear of new administration. Now, we've seen the budget, and we're saying, "Hey, they can live with this," so we're seeing the bounce back. The budget is out now, we can actually look at it, it is flat down. Investment spending, which is the contractor portion of a bigger pie, is down, but only down by about 1%, it's $248 billion, that's about $200 billion better than we expected. R&D, which tends to be a higher margin than a new ship, R&D is up. What we found in the last couple of months, as the budget started to take shape, is the worst fears weren't going to be realized, and the stocks recovered. I think it makes sense, I think people who were listening to the two of us last year might have seen this coming. But I think the sell-off is overdone and so this is more of a bounce back than a Biden defense rally or something like that.
Sciple: Not to get too political here, but I think when you think about some of the priorities of the Biden administration and that we want to stimulate the economy, we want to create jobs, all of those sorts of things, it's always challenging to get these types of stimulus spending bills passed. Well, one thing that can stimulate the economy and create jobs like we're seeing with Huntington Ingalls and that tends to be supported on both sides of the aisle, at least on spending more, is defense. It's one place where you can get both sides to agree, "Hey, we can spend some money on defense." Actually, in this environment, if you look at some of the priorities of the administration, you could tell a story about how there's probably some support for defense spending. When you look at the sector today, Lou, obviously, a lot of these companies are up significantly so far this year. They still seem attractive, or do you think the valuation is normalized? What are your thoughts?
Whiteman: I thought some of them looked attractive before the sell-off, and so now that it's back, I got -- My feeling of relative attractiveness really hasn't changed. I thought there were some screaming buys last year before the sell-off but it's funny to look at, because they were the best performers last year when they were only down 8%, when some were down 20%-30%. I do think, for long term holders, especially those who are interested in income, because you get dividend yields of 2%-3%, I don't see anything in the winds that makes me think this sector is going to hit the skids. And remember, on the politics on all of this, as I said, with Huntington Ingalls, most of what they are building today was allocated years ago. The weird cool thing about investing in this sector is that with this one customer, and this customer is so transparent with its plans with a five year outlook on what they want to spend every year, you have that, you have backlogs in the tens of hundreds of billions for these big companies. Even if defense spending falls off the cliff, that's a 2030 problem at this point. There is a sleep at night, it's not going to give you cloud stock appreciation sometimes but dividend focus, sleep at night, steady growth. Nothing has changed in the last year, as they've gone down and up, that changes my opinion on that.
Sciple: Yeah, and this is the type of sector that frankly you don't want hyper-growth, because that means some bad things are happening in the way. You want it to be just steady, the walk softly and carry a big stick type of spending.
Whiteman: Very good point. Yes.
Sciple: Moving on, last story. Boeing has been all over the news in the past couple of years, whether that's the 737 MAX or any number of other issues that have befallen Boeing. Got to grab a bag of news of Boeing this week. What's happening with this company?
Whiteman: Maybe I'll try and go bad to good here, because Boeing has had a year's worth of news this week. As part of this budget process, we're going to have hearings, and the House Defense Appropriations Committee brought up in the Air Force budget hearings apparent or alleged overbilling in the KC-46 tanker spare parts contracts. These are actually spare parts headed for Japan. Japan is about to take the tanker. It's only an $88 million contract, but about $10 million of it, the Air Force basically said, look, we can't explain why we're paying what we are. This is a program that has caused Boeing about $5 billion in overruns, and it's led to a lot of grumbling inside the Pentagon, "Oh, here we go. Here's how they're going to get it back." It's gotten the lawmakers and it's another black eye. Now, I'll say in this case, the KC-46 is based on the 767 which is a commercial plane. The commercial supply chain was thrown into disarray by the pandemic last year. Price quotes were probably really hard to get, and at least with one of these products, Boeing has said, "Look, we were underpricing it for a long time. If you don't believe us, we release you from your obligation. You can just go buy it from Honeywell directly."
The Air Force looked into that and said "Never mind," which makes me think this is probably no big deal. But again, you don't want Congress people yelling at you for cheating the government at budget hearings. So it's part of doing business, but it's also not great for Boeing. Good news is they did have good news this week. Maybe one of the coolest things they're doing, their Stingray Drone, which is designed to refuel F/A-18 Hornets in-flight off enabled carriers, this could really be a game-changer for the attack plan with the carrier because it could add 400, 500 nautical miles of range to really keep the carriers out of danger. It completed its first successful in-flight refueling. It was within 25 feet at full speed, filled the tank, which is just amazing to think of. This is a real priority for the Navy. Upwards of 30% of its fighter jets at any given time in a combat scenario are designated tankers just for refueling. If you could do this with drones, this is a way that you can get more bang for your buck without a huge investment.
The fact that this works, I think they still have a lot more testing, but this could turn into a +10 billion opportunity if it works. The first test, from what they say, went off without a hitch. So you have that going from on the defense side, Southwest continues to buy planes. They added 34 to 100 plane orders. These are the smaller 737-MAX 7s, which were kind of a hard sell until now. You have that and we may have, with President Biden over in Europe for the Summit, it looks like we may finally have 20 years of tariff wars ending, which would be really good news for both Boeing and Airbus. But it's been a you-blink-first situation that maybe we can get past. A lot going on with Boeing, and more of it probably good than bad right now.
Sciple: You mention that one parts deal. With some of these issues, Boeing has had the past couple of years, maybe they get less benefit of the doubt on some of these things than they would have gotten previously. But yeah, a huge win there with the drone. Then when you look at Southwest, they've always been a key partner for Boeing. What do you make their move to just keep pressing in on the 737 MAX? Do you think that's been a good strategy from their perspective?
Whiteman: This was a plane that they couldn't decide if they wanted to take. This was a real concern for Boeing, because the smaller MAX isn't necessarily the plane they wanted. Boeing doesn't have a good 120-160 seater right now. They were going to get that through a joint venture with Embraer, but that fell through during the pandemic. There is an Airbus plane that is a great fit for this market. Southwest actually flirted with Airbus there, which would have been a huge symbolic blow. It's good to see Southwest doing the initial deal, it's good to see them hanging on. I will say this, the reason Southwest is who they are, and is the stock that it's been, is they take advantage of downturns. I think these deals are probably good for Boeing, because they are moving metal and they are reaffirming a very important relationship. I'm willing to bet Southwest is getting a steal and a half on these planes. The fact that they are recommitting to it where they're not going to get deliveries from years out, that just tells me that this is a price where it may not quite be BOGO, buy one, get one free, but it's getting toward those levels so it probably makes sense for Boeing anyway. You need to rebuild this line, you need to establish the partnerships, you need to move inventory after the MAX is grounded for 18 months. But economically, I don't think it's the home -run that we would have imagined prior to the grounding, just 100+ order for the MAX.
Sciple: The leverage shifted during that period where they had to ground all those planes from Boeing.
Whiteman: Very much.
Sciple: Whereas Boeing, "I have this huge backlog, you better pay me to get your piece of this backlog." Now, it's Boeing, "I need to sell these planes, I need to get these off of my lot and actually to customers" and that mistake with the 737-MAX totally shifted the negotiating dynamics in the industry away from Boeing's favors. You mentioned as well this tariff potentially lifting these issues between Airbus and Boeing. Clearly, you can see how this benefits both of them. Boeing can sell more into Europe and some of these other markets, Airbus can sell more into North America. Who do you think wins more from this, though, in your opinion?
Whiteman: The real winner is the airlines. That's part of what's pushing this, is after the pandemic, there was a real talk of, you guys got to play nice because, at the end of the day, this adds to our cost and for a long time, we can't do it. I think all-in, it benefits Boeing, just because Airbus has such substantial domestic operations. Now, there have been some complaints on that and parts and all that, but it's a win-win for both. They've basically neutralized each other on tariffs. They'd both yell at me for saying that, which tells you that they really have neutralized each other. But this is just a stupid hassle and the second it's resolved, I'm sure it'll open up again from both of them on a new front where they see some other unfair. But it's just been a cost to doing business for 20 years so it's time to clean the slate. Looks like it will probably start over with new complaints.
Sciple: Moved to a different battleground, right? We mentioned right when we started off this segment how it has been going through a gauntlet for Boeing over the past couple of years. Do you think Boeing is out of the woods yet? What should investors be watching for?
Whiteman: It's almost in a few ways. The worst is over, and the worst has been over for a long time. But as you mentioned, greater scrutiny from lawmakers, greater scrutiny from the FAA right now too. After what happened with the MAX, you've seen both the MAX and the Dreamliner production shut down this year for various points for relatively minor issues, or addressable issues, where in years past, it might have been, keep it running and figure it out. The FAA said, "No, you stop and you figure this out." That's going to take awhile. It doesn't really stop the business, but that's a crimp on the business. But I think the worst is over. I wonder how long it will take to really see the up-cycle. I will give you two things that I think you should be looking for right now, that are really going to be, in my mind, the green light, a "go" sign.
First of all, China still hasn't recertified the MAX. That is a regulatory thing with the plane, but it's geopolitical and what's been going on between China and the United States over the last, how many years? This is a huge piece of leverage they have. I've seen some -- it feels like constantly now, I've been seeing it, any day now or in the next few weeks, we're going to see China given the green light. I've been seeing that since the end of last year. I have no idea when that's going to happen. My sense is that China likes having this leverage, and look, China represents maybe 40% of the global potential order book for narrow bodies like 737. This is a huge deal and it really does impact Boeing, so I want to see that resolved before we get too excited. Second thing, and the real big, the next big up-cycle, I think is going to be in these wide-bodies, whether it's the 787, the new 777-X which they can't move right now if they try. These are the international planes, with the two aisles down the middle when you're flying internationally. More than 20% of the global fleet, possibly 25%, is over 20 years old. These are not fuel-efficient, but they're very expensive. Right now, in this market, there's no real hurry to get rid of them.
When airlines feel confident, and when their balance sheets are ready post COVID, and when they see that demand, you are going to see a flood of orders, I think, for wide-bodies. It might be the second half of this decade, it could be sooner, or it could be into the 2030s, but it will happen. That is probably the catalyst for the next big up-cycle in commercial aerospace. Maybe it's too late to climb on board by then if it takes too long because people have [...] warm into the stock. But I think people do underestimate how long -- we've had such an extended up-cycle last time around, I don't think it's a given that the next one starts anytime soon. Reading the tea leaves on wide-body demand, reading what the airlines want, I think is a pretty good thing to watch in terms of getting a feel for when things really heat up again.
Sciple: I love it, Lou. Always love having you on the podcast. Until next time.
Whiteman: Always good to be here, Nick.
Sciple: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for mixing the show. For Lou Whiteman, I'm Nick Sciple. Thanks for listening and Fool on!
