The COVID-19 pandemic hit the aviation industry hard and hit the share prices of stocks in the sector. However, instead of thinking of the industry as a victim, it's time to consider that a multi-year recovery is now in place. As such, there are good long-term value opportunities in the sector, and I think aviation services company AAR Corp. (AIR -3.44%), Brazilian airline Azul (AZUL -1.42%), and advanced materials company Hexcel (HXL -1.48%) are worth a close look. Here's why.
Domestic travel is leading the recovery for Azul
Most industry observers expect domestic flight departures to return quicker than international flight departures out of the recovery. The reason is that ongoing cross-border travel restrictions will constrain a recovery in the latter. It's a viewpoint borne out in several metrics across the industry. For example, narrowbody flight departures are recovering faster than widebody flight departures because larger aircraft are used relatively more for long-haul flights.
It's also reflected in the traffic data for Brazilian airline Azul. The largest airline in Brazil, Azul's fight departures are overwhelmingly focused on the domestic sector. The chart below shows Azul's passenger traffic figures for February. The domestic traffic figures are already ahead of 2019, and its international traffic is in recovery mode.
According to Wall Street analysts the recovery will result in Azul turning profitable in 2024, and the company's exposure to the growth potential of the Brazilian economy should ensure earnings growth for many years to come.
AAR Corp. keeps expanding its margin
Small-cap company AAR Corp. is an aftermarket solutions company to the global aerospace and defense aviation markets. That means providing parts, maintenance, repair, and overhaul services to commercial aviation and defense customers. As such, it's a play on a recovery in commercial flight departures and ongoing servicing of government and defense customers.
For reference, commercial customers include Deutsche Lufthansa, Delta Air Lines, and United Airlines Holdings. ARR counts the U.S. Air Force and the U.K. Ministry of Defense as customers on the government side.
So far, trading in its fiscal 2022 (AAR's financial year ends on May 31) has been excellent and confirms the thesis that the company is heading for a sustained recovery. On the recent third-quarter earnings call, CEO John Holmes noted: "We have now delivered our sixth straight quarter of adjusted operating margin expansion, and our margins are exceeding pre-pandemic levels. We are extremely proud of this progress, particularly since we have not yet seen a complete recovery in commercial sales."
Wall Street analysts agree and have ARR increasing sales at a high single-digit rate over the next couple of years, leading to earnings per share of $3.28 in 2023. Based on the current market price of $48.62, that would put AAR on a price-to-earnings ratio of fewer than 15 times earnings in fiscal 2023 -- a good value for a company still in recovery mode.
Hexcel to the future
Advanced materials company Hexcel sells its carbon fiber reinforcements and resins to commercial aerospace (50% of sales in 2021), space and defense (33%), and industrial markets (17%). However, the key to its growth prospects lies in its commercial aerospace sales.
Hexcel's advanced composites have a weight and strength advantage over metals. The key advantages of using carbon fiber composites on aircraft include reduced fuel use and emissions and lower costs over the aircraft's lifetime. These benefits translate into increased penetration of advanced composites on newer aircraft, such as the Airbus A320 NEO family, the Boeing 737 MAX, and widebody aircraft like the Airbus A350 and Boeing 777X.
You can think of Hexcel as a play on an increase in aircraft production (Boeing and Airbus are both ramping up production rates) and an ongoing rise in Hexcel's revenue per plane as advanced composites are used more on newer planes. It will take a while to return to the 2019 level of sales. Still, as aircraft manufacturers engage in a multi-year production ramp-up and newer models replace legacy fleets, Hexcel has many years of growth ahead.