On this episode of Industry Focus: Energy, host Nick Sciple is joined by Motley Fool contributor Lou Whiteman to answer a question from the listener mailbag and take a look at three under-the-radar aerospace stocks
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This video was recorded on September 30, 2021.
Nick Sciple: Welcome to Industry Focus. I'm Nick Sciple. Today, Motley Fool contributor Lou Whiteman joins me to take a look at some Aerospace stocks that are flying under the radar. Lou, welcome back on the podcast.
Lou Whiteman: Glad to be here.
Sciple: Great to have you here. We originally planned to maybe do This show last week. But you had a little bit of a busy week.
Whiteman: I got to find out the fun of 100-year-old cast-iron pipe leading out to the sewer and what that means for homeowners and on an unplanned bill. Yes. No, I was spending money, not making money most of last week.
Sciple: When you go shopping for houses you're typically looking at the stuff that's above the ground and that's really what's your fall in love with. Little do you know you're also are buying all that stuff underneath the ground and sometimes that comes back to bite you. Hopefully, all home improvement work is done. But we'll see how it goes.
Whiteman: Hopefully, yes. Thanks for joining us, you'll be there next. But yeah, all I want is flushing toilets. Is that too much to ask.
Sciple: That's a very important task. Getting into our main topic for the show. We are going to talk about Aerospace stocks that comes in response to an email from our listener, Alan, who wrote us at [email protected]. He said, "I began working at Alcoa Howmet castings in 2006, they acquired several companies to bolster their share in the Aerospace market. This was then spun off into Arconic a few years later. Now, in 2021 we find ourselves spun-off again into the Howmet Aerospace (HWM 3.00%). At the low point of the pandemic, our sales were cut nearly in half. Today, we are back to pre-pandemic levels. This is just the plant I work in, making turbine blades for jet engines. He's like, "Our thoughts on the broader Aerospace segment and outlooks going forward." Says PS, He's kept all of his stocks and they've all done well. Speaking about how Matt just brought to mind for me, there is a lot of Aerospace stocks probably don't talk about enough. But before we get into some of these companies, specifically Howmet, we will start with. When you look at the broader Aerospace segment at large, Alan asked about the outlook for the broader Aerospace segment going forward. You had to zoom out and give the 10,000 foot view, if you will, to use a pun. What do you think about the segment today?
Whiteman: Yes, exactly. The aerospace companies provide your view from 10,000 feet. Broadly, aerospace is about two sides for commercial and defense. Commercial is the Boeing Airbus (BA +2.57%) The airplanes that take us from point A to point B. Then over defense, to some extent the planes there for us, but a lot of times when you hear it used, it's just defense companies and there are many different things. It's been a bad couple of years as we know because of COVID, however, the future for air travel, especially on the commercial side of it because most of what we're talking about today is commercial, the future is bright. This is a world where the developing world is developing. There's a lot of demand from all ports of the world. The international trade group still has a 20-year forecast of 10-15% annualized growth. Boeing thinks it will sell. It sees opportunity to sell $9 trillion worth of planes over the next decade. COVID has eaten into This business in the near-term but there is still a lot to be bullish about in terms of commercial aerospace and demand for travel.
Sciple: People like to get out of their houses. They like to travel. To the extent they are allowed to and feel safe to do so. I think that long term trend is still intact and these companies really help service that. Also you mentioned the defense side. That's really aircraft carriers are the most important shit these days. Why? Because planes are the most important tool as far as we're fighting. Maybe taking that 10,000 foot view, let's now maybe zoom in on a few aerospace companies that probably don't get the headlines that a lot of others do. The first one Alan mentioned, Howmet Aerospace, that's company that he is connected with. He gave us the pre-history, lots of spins here. What's the pre-story here with This company?
Whiteman: This is a fascinating story and Alan, I'm so happy for you that you're doing well with This because This has been a frustration for so long. If we have to go back about 10 years to Alcoa, the aluminum manufacturer. They were very much a commodity company that ebbed and flowed with the commodity cycle. Their CEO had the idea of, let's buy some of the parts that are made with aluminum. Those parts are profitable or not-profitable, whether aluminum's at a dollar or $500 a unit. This way we can get some of the cyclicality out of their stock. Unfortunately, Alcoa announced This to the world that they were doing This. They honestly did a poor job overpaying for assets and then they get almost no work to integrate them or to make This into a company. When the stock price didn't improve, Alcoa and Arconic split out. Alcoa went back to being a commodity player and Arconic was supposed to be finished products. The CEO that screwed up the initial plan went with Arconic and screwed that up further, if I'm going to be honest. They finally got rid of him. They brought in good management and that management decided, let's spin this out further and just have a aerospace-focused business. The legacy Arconic is now other finished products, a lot of auto. But what is left was This really interesting group of assets that are very important. Howmet makes a lot of the metal parts. We're talking fasteners. We're talking just components, little things that are essential for aircraft engines. It's a great set of assets that was frankly mismanaged for the better part of a decade. Alan stuck in there. I think it's an interesting story to look at because there was always a gem of a company now and they finally have a management team that's polishing that gem.
Sciple: Through all these spin outs and all these troubles, we finally boiled it down to: there's some good stuff left here in This Howmet company. Why in particular are these assets so attractive? Is it margins or the recurring nature of their use? What makes them particularly attractive?
Whiteman: It's a mass production. We'll get to that too, the downside, the risk of the stock. But yet This is about a five-billion-dollar maker, of like I said, mostly metal components. A large part of it is what goes into the engine. Above about 40% of the business is commercial aerospace, 20% defense, and then they had some energy and other transport. Nearly half of their total sales go into engine parts, an engine could be definitely the most expensive part of a plane. The interesting thing about This business, partially because of COVID. It's all aerospace revenue declined as a total portion. They've been trying to diversify the 787 Dreamliner, Boeing's plastic plane. They make a lot of engine parts for that. The Dreamliner has struggled so too have companies that supply to Dreamliner. They have been looking to diversify and actually I think that the aerospace assets valuable. But I think there is a lot they can do in other areas and it's exciting. They are mostly original equipment. They aren't as big as spare parts, the so-called aftermarket as some of the companies we'll talk about today. There tends to be more margin pressure on that but it's also reliable business and steady business, especially when times are good and post-COVID when we're actually making planes and filling orders.
Sciple: When you supply these OEM components, would you say these customers or these businesses that are on the OEM side may be more subject to cyclicality than the replacement part businesses?
Whiteman: They can be. You see both sides there. You see more of the boom side too though, so you have good times when things are up. The aftermarket tends to be more steady and more reliable. Yeah, you do have a little bit more of a cyclical play. But look, there is real long-term demand. We mentioned Boeing's nine trillion-dollar market. It is a market that ebbs and flows, but it's also a great market to be in for the long term.
Sciple: If you look at the stock, I think the market probably agrees. You mentioned how 2020 is a challenging time for the stock will post-spin. It's up about over 150% versus just about 80% for the markets, about doubling performance of the market. What do you make of it is performance so far and where it can go from here?
Whiteman: It's an interesting stock. It's not one that I am tempted to buy at this level. I almost bought it way back during COVID and I really wish I had because I really like the assets. It's a reasonable valuation here, but enterprise value about 20 times EBITDA. We're going to talk about a company in a second that has doubled that. Even Hexcel may be a better comparison because they aren't valued like that. They're even trading at discounts with them. The issue for this business is that you are in the middle of a complex supply chain and will you have pricing power? Some of these past managements, which admittedly again, I don't think they were all stars, but they complain this was deflationary business that you're never going to see pricing. Part of that, maybe excusing bad performance, but they have a point. One of their primary competitors is Precision Castparts, which is a very well-run company that is now owned by Berkshire Hathaway. It was always a great company and now it has Berkshire's assets and resources. It also doesn't have that quarter-to-quarter pressure. It's a good company in a tough business. I think the stock can perform, but I don't know if fits. I like other stocks we're going to talk about as overachievers better than this company right now.
Sciple: It may grow with the market, but you don't see it being the star of the class if you will.
Whiteman: Yeah, that's a good way to put it.
Sciple: We mentioned earlier how that emerged from a more complicated business and really boiled down to these really attractive aerospace parts. We might be with this company we're going to talk about now in the earlier parts of that stages before maybe the aerospace parts get bought out. This one is Ball Corp (BLL +0.86%). What can you tell us about Ball Corp and where they plug into aerospace?
Whiteman: Ball Corp, I think most people know them for the iconic mason jars that they are mostly still a maker of soda cans, packaging, things like that. They have an aerospace unit though that dates back to World War II. A need to diversify and just a real opportunistic management team that saw an opportunity and went for it. Aerospace is a small part of what Ball does. It's a big company. It has about 13% of 3.5 billion in revenue in the most recent quarter, but it is a substantial and growing part. The backlog is about three billion dollars, five billion if you count orders that haven't been funded yet but should come in. Ironic here because given Ball is a soda can maker, this is probably the least metal-focused business of the three aerospace we're going to talk about. They do make some metal parts, but mostly they are defense, electronics, and space. A lot of sensors, a lot of antennas, big testing business, and engineering business, the last big contract they saw was a $200 million Air Force steel to develop ways to foil cyberattacks on fighter jets. It's always been an opportunistic business. They do very little M&A. If they want to grow outside their core competency, they're going to buy it. Ball has been a very acquisitive company by basically consolidating its core business. A lot of it is organic and just seeing opportunities using the cash they have and investing that cash wisely. I think it's a neat little business that I mean, for a radar company, it is under the radar, but you don't think of it as an aerospace business. But there is a lot to like there.
Sciple: It's one of these where you have this high-tech space, adjacent company, embedded inside this really boring packaging maker. You don't think of soda cans as high-tech at all or mason jars is like the opposite. You get that if you want that farmhouse feel in your house, so you go and get some Ball mason jars. Is this a company you think there's a case to be made to spin out the aerospace business and get a higher multiple?
Whiteman: It's still a relatively small business, so I don't know if the case is there yet. The stock hasn't been a great performer, let's be honest. I looked it up, the stock is down about 4% year-to-date. It's the worst-performing one we've talked about here. Maybe, but I think they would have to grow the business further. It wouldn't be very tax-efficient, but I'm sure if they could find a tax-efficient way to sell it, they could take a really good value that way. I don't want to compare it to Berkshire Hathaway because it's a very different company, but the same idea of generate cash and deploy the cash in attractive areas, I think that's a decent strategy at least for now, for them to try and grow it and see what it becomes.
Sciple: Yeah, I think certainly under the radar, it's hard for me to get as excited about that maybe packaging business as you can for aerospace. But it is one that if these assets ever got gobbled up, if I ever saw a headline that said XYZ aerospace company acquires Ball's aerospace assets, or if you saw this get spun out, it would get my antennas up. One that I think is worth being aware of and having on your radar at least to a certain extent. Let's go now to the third company we're going to talk about today, that's HEICO's (HEI 0.53%) alked about Howmet Aerospace addresses the OEM market, the new parts, HEICO other side of the market?
Whiteman: Yes. This is by far the all-star at these companies. This is a diversified manufacturer and it's a family run business for better or for worse. Laurans Mendelson is the CEO. He acquired the company decades ago. He still runs it but his two sons are co-presidents. The family owns 15% or more of the stock, dual-class, so it's higher ownership. But wow, has this been a performer. It was the top-performing aerospace and defense stock of the last decade up 1,200%, continues to do well. It's best known as you say for its aerospace and particularly spare parts, but it also has significant other businesses. About half of sales come from outside of commercial aerospace. Some of that's defense, but a lot of it is electronical components in other industrial, they were probably the best performing aerospace stock during COVID because in part they have a medical device business. They don't make devices, but they make a lot of the electronics that go into them.
Parts of their business actually held up real well and saw demand rise during COVID, which was an interesting moment. They are very similar to a company they're often compared to and that I've talked about a lot, company TransDigm (TDG 0.92%); focused on the aftermarket, and what they do is they look for opportunities, especially through acquisitions, to find businesses that are both necessary for these planes to operate, but also hard to commoditize because either they're patent-protected, or it's too specialized to really just runoff an assembly line. It is a very lucrative niche when you find it. This is a company, as I said, it's done real well over the last decade or so. They are underwhelmed with their most recent earnings. They only beat because of tax benefits, their operations were light and they sounded the alarm that maybe investors are too excited about the recovery and what they've done. But as a long-term performer going past the blow-by-blow, it's hard to complain about what HEICO has been able to do.
Sciple: You talked about the really strong performance that HEICO has, focusing on all these niche products, same basic strategy as TransDigm. A question I always have with these is they've been running this roll-up strategy for the better part of a decade. How much more juice is there in this strategy and how many of these small types of part manufacturers are there, out there, for these companies to keep growing and acquire?
Whiteman: I think that's a fair criticism. You've seen TransDigm has gone to much bigger deal. What TransDigm has started to do, they attempted to buy Meggitt, they've just backed off of that, but they bought another British company where they buy whole companies and just spin-off what they don't want to or sell what they don't want. Because a lot of these have been rolled out, but there are opportunities. I think a bigger concern is that as engineering improves in newer models, you have more uniform parts. Boeing and Airbus are always trying to commoditize their supply chain as the best they can to keep it low cost. There are more opportunities on the planes that are being retired now than there are planes being introduced to service. But there is still a lot of demand out there. I mean the global air fleet is massive and there is growth to be had for the foreseeable future, just doing what they do with opportunities, mostly carve-outs of other businesses that are out there. But no, I think to your point, it's fair to say some of the lowest hanging fruit has definitely been picked.
Sciple: When you look at the stock today, what do you make of evaluation and then future opportunity for investors?
Whiteman: The stocks flat on the year, and I think part of that is, because as I said, it didn't fall as much during COVID and it was an early beneficiary. We all knew, even as air travel was going to slowly resume, that airlines weren't going to be buying new planes. The spare part business came back faster than new equipment. This is a best-of-breed company. We talked earlier about valuation. This is the stock that has doubled what Howmet traded about enterprise value of 40 times EBITDA. That's even higher than TransDigm, which is about 27 times. The family ownership thing has always got me a little lively, I like the skin in the game and I like parts of it. I wouldn't sell this if I owned it. I've always favored TransDigm and I still do. I like just parts of the model better. But look, HEICO is a solid performer that has a track record of delivering, and I see no reason to think that that's going to stop anytime soon.
Sciple: Great. I guess the family gives you a certain stability and we're going to keep the same strategy in place and all those sorts of things. You mentioned that this huge multiple difference you see between the aftermarket part makers and you mentioned Howmet, the OEM makers. Why such a big valuation gap?
Whiteman: To some extent, as I said, the manufacturers are trying to commoditize their supply chain. They are buying in bulk a lot, not everything, there are still some opportunities because some parts are just specialized, you can do patents. But buy in large, the newer planes with the bulk orders of new manufacturers versus legacy planes where the spare parts are harder to source. Also, part of it is that the just-in-time inventory. Some of these parts, if you're Delta Airlines or something, you may only need this part 20 times a year to fix an engine. But you darn well better have it that day if you need it. The beauty of TransDigm is it's a logistical play or its ability to meet those needs. People have been talking forever about TransDigm routinely does 40% plus margins. People have been saying forever that's not sustainable. The truth is, the reason it is sustainable is because the customer sees value in what they're getting. Yes, it's not a perfect form, you can't just buy anything. But it has worked really well over the years, especially with the make up the airlines right now and put them leaning on their existing fleets. There is a lot of opportunity for the foreseeable future.
Sciple: Yeah. Just-in-time inventory part really is the double underline for me, why you have so much more pricing power in this industry. Because I don't know if you're like me, but I've been stuck at an airport terminal because they said there were maintenance issues and I would pay whatever amount of money it costs to get me on that plane faster. Don't you know, any of these airline companies are tired of hearing the customer complaints as well and they'll pay TransDigm whatever it costs or HEICO or any of these aftermarket folks to get that product as quick as they possibly can, and that delivery comes at a premium.
Whiteman: Absolutely. Airlines make money when their planes are moving, yes.
Sciple: Facts. We've talked about a few under-the-radar companies. If your company's under the radar, maybe our potential investments for you. But if you're someone who doesn't want to look under the radar, you want to stay above the radar and just pick a company that just gives you a comfortable exposure to aerospace for you, what would be your recommendation for a beginning investor or the stock that would come top of mind for you?
Whiteman: I've already spoiled it. But TransDigm for me, if you own one commercial aerospace stock, TransDigm is the one to own. It's not cheap, although as I said, it's not as expensive as some. I loved the track record. They've been bruised because of their debt, but I think they are dealing with that especially now if they're not going to buy Meggitt. They're at a constant criticism because people look at the margins they get and complain that they're ripping off the Pentagon, unless they don't get those margins from the Pentagon side. But it's a battleground stock, so you get it at a discount to HEICO. I love this company and if you want exposure to commercial aerospace, I think that that is your one-stop shop.
Sciple: Lou, always love having you on the podcast. Alan, I hope we answered your question. But if not, we'll have Lou on again sometime soon to dig into another niche in aerospace. Till then, Lou, thanks for joining me.
Whiteman: Always a pleasure.
Sciple: As always, people on the program may own companies discussed on the show. 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!
