It's shaping up to be an exciting month for the aerospace sector. Two of the three companies featured here, namely Raytheon Technologies (NYSE:RTX) and AAR Corp (NYSE:AIR) will be giving earnings with CAE (NYSE:CAE) to follow in August. According to Wall Street analysts, all three will report positive revenue growth after several quarters of declines. I think that could change the narrative around these stocks and lead investors to consider the exciting growth prospects of all three. Here's why.
The projected improvement in sales in their respective quarters is graphically represented in the chart below. Of course, this reflects that the aviation markets fell off of a cliff in the second quarter of 2020 as the pandemic spread globally. So, looking at it pejoratively, all that's happening is that the industry is about to lap some easy comparisons with last year.
That said, stocks have no memory, and what matters now is their current valuations relative to their growth prospects. On that basis, these stocks are attractively valued; not least as they can emerge from the pandemic stronger than when they entered it.
The company began life as Canadian Aviation Electronics, ultimately ending up as CAE Inc in 1993. It produces flight simulators and training solutions for the civil aviation and defense and security markets. Over 60% of its revenue is recurring in nature, granting it some stability in typical situations. In addition, the company has a long-term revenue and margin growth opportunity by taking advantage of its leading position in simulators in growing its training services business.
In a nutshell, it's a play on the need to train and retrain pilots. That may well seem like an unattractive proposition in the current environment, but the reality is that there was a shortage of commercial pilots going into the pandemic. Furthermore, many airlines have been retiring older pilots during the pandemic and neglecting to train new ones. As such, there's a good chance of significant pilot shortage when commercial flight departures recover to 2019 levels.
In addition, CAE has been busy consolidating the market during the pandemic. The company recently completed the acquisition of L3 Harris Technologies' military training business for $1.05 billion and agreed to buy Textron's commercial flight business for $40 million.
CAE still has near-term headwinds, but everything points to CAE emerging as a stronger company over the long term.
As commercial flights come back, so will the need to service and provide parts to airlines' aircraft. That's where independent aviation services provider AAR Corp comes in. The company distributes used and original equipment manufacturer parts and provides aircraft repair and engineering services and inventory management. Examples of its customer base include commercial airlines like Lufthansa, United Airlines, Southwest, and cargo airlines (UPS, FedEx, and DHL). In addition, government customers, including the U.S. Air Force and U.K. Ministry of Defence, use AAR.
It's long been an attractive business to be in as aircraft parts are tightly regulated, meaning there's a natural barrier of entry. In addition, they are a critical component of airlines' operations. In addition, AAR has a long-term growth opportunity from the use of digital technology to collect data and better service customer needs. That's a win-win scenario for AAR and airlines.
AAR is a small-cap company with a market cap of just $1.3 billion, but analysts expect it to generate more than $300 million in free cash flow (FCF) over the next three years, or 24% of its current market cap. If you believe the commercial aviation market is coming back strongly, then AAR is a very attractive stock.
Last but not least, the commercial aviation and defense giant is probably the safest way to play an aviation recovery. The company's defense business (missiles, space, and intelligence) will support it with earnings and cash flow through the recovery period. Meanwhile, the commercial aviation business is so comprehensive that it would be very hard not to benefit from a recovery.
From aerostructures to cabins, flight decks, power units, avionics, interiors, landing systems, etc, Raytheon offers a host of original and aftermarket parts on aircraft through its Collins Aerospace business.
However, its most exciting business is probably Pratt & Whitney aircraft engines, specifically the geared turbofan (GTF) engine on the Airbus A320 NEO. Unfortunately, the pandemic has undoubtedly set the GTF program back. Still, as GTF engine production ramps up again, investors can start penciling in a couple of decades' worth of very lucrative aftermarket revenue on the GTF.
CEO Greg Hayes has $8 billion to $9 billion worth of FCF in his sights over the next several years, and if Raytheon can get there, then its current market cap of $128 billion will prove to be an excellent entry point into a good long-term growth story.