A full recovery in commercial aviation will take time, but it's a question of when, not if. So if you want to play a multiyear recovery in the sector, then stocks like aerospace and defense company Textron (TXT 0.40%), pilot training and simulator company CAE (CAE -1.90%), aerospace and defense giant Raytheon Technologies (RTX -0.04%), small-cap aviation services AAR (AIR 1.88%), and advanced-materials company Hexcel (HXL -0.81%) are excellent ways to gain exposure. Here's why.
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Textron can soar again in 2022
Textron stock soared more than 50% in 2021, and there's reason to believe it can continue. The industrial, defense, and aerospace company operates out of four segments, Bell (military and commercial helicopters), Industrial (specialized vehicles, fuel systems, and functional components), Textron Systems (military hardware, robotic land vehicles, air support for the U.S. military), and Textron Aviation (business jets and planes).
The big story of 2021 was the resurgence in profits at Textron Aviation (with its Cessna and Beechcraft brands) as the business-jet market recovered strongly. The segment was responsible for $333 million of the $397 million increase in operational profit in the first nine months of 2021. A combination of a recovering economy and the frustrations around commercial aviation travel during the pandemic seem to be encouraging spending on business jets.
These favorable conditions should continue, with Honeywell's Global Business Aviation Outlook noting that "business aviation usage trends point to a nearly 50% increase in flight hours in 2021 versus 2020, roughly 5% above 2019." Furthermore, it said, "Operators plan to make new jet purchases equivalent to about 14% of their fleets over the next five years as replacements or additions to their current fleet."
It looks like another good year for Textron.
CAE invested during the downturn
The aviation industry faces a potential shortage of pilots in the next couple of years. The pandemic caused early pilot retirements, a lack of new pilots entering training, and an industry exodus by many junior pilots. Throw in the need to train pilots using new digital formats and retrain rusty pilots, and the outlook is positive for market-leading pilot training services and simulator company CAE.
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Management spent much of the pandemic acquiring a slew of training and simulation businesses to consolidate the market and prepare for post-pandemic growth. In particular, growth in higher-margin training services provides the company with a way to expand revenue and margin in the future.
Management's actions are likely to prove perspicacious in the coming years as the market for pilot training picks up.
Raytheon Technologies' balanced growth
This behemoth offers a combination of defense and commercial aviation businesses. The former supported the latter during the worst days of the pandemic. However, its commercial aviation businesses (Collins Aerospace and Pratt & Whitney) are set for a multiyear recovery and will take up the growth baton from the defense businesses (Raytheon Intelligence & Space, and Raytheon Missiles & Defense).
CEO Greg Hayes believes Raytheon will generate $10 billion in free cash flow by 2025. That's a considerable number, representing around 7.4% of the current market cap of $135.8 billion.
If Raytheon hits Hayes' target, it will look like an excellent value stock. Its defense revenue is relatively stable. In addition, Collins Aerospace's original equipment manufacturer (OEM) sales should be in growth mode as airplane production ramps up, and Pratt & Whitney's engines should have decades of aftermarket growth ahead of them.
AAR and Hexcel
Hexcel is a play on the OEM market and the trend toward Boeing and Airbus using its stronger, lighter advanced composites as part of their more-modern aircraft. Given that the aftermarket is very limited for such products, buying Hexcel stock is a vote of confidence in production ramp-up at airplane manufacturers.
In addition, with more content per plane on newer models, Hexcel is likely to generate significantly more overall revenue when unit volumes return to 2019 levels. Let's put it this way: In the three years before 2020, Hexcel generated an average of $246 million in free cash flow (FCF). Given that the market cap is just $4.8 billion, Hexcel would trade on less than 20 times FCF (at the current market cap) when it gets back to 2017-2019 levels of FCF. That would be an excellent valuation for a company with such strong growth prospects.
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In contrast, AAR is a play on growth in aviation services. It offers parts supply (used and OEM factory-new parts), repair and engineering, and flight and logistics support for commercial and cargo airlines and the military. Customers include Lufthansa, American Airlines, Delta Air Lines, Southwest Airlines, FedEx, UPS, and the U.S. Air Force.
It's a business that will grow in line with the recovery in-flight hours and AAR's ability to grow contracts. So far, so good. On the second-quarter earnings presentation in December, CEO John Holmes said: "We delivered our fifth straight quarter of adjusted operating margin improvement and are now exceeding pre-pandemic levels. We expect this improvement to continue as our higher-margin parts activities fully recover."
Wall Street analysts think AAR will generate around $100 million a year in FCF in the 2021-2023 period, or around 6.7% of its current $1.5 billion market cap. AAR represents an excellent value play on a recovering commercial aviation market.
