The aerospace sector is an excellent place to invest in 2022, and for those looking to open positions, few options look more appealing to me than aerospace and defense giant Raytheon Technologies (RTX 0.68%), advanced composites company Hexcel (HXL 1.49%), and aviation services company AAR Corp. (AIR -0.75%). Not only have they been significant outperformers so far this year, but their earnings momentum is improving. As such, investors have good reasons to continue to be optimistic.
The best aerospace and defense stock to buy
The long-term case for Raytheon is excellent. Its commercial aerospace businesses -- largely Pratt & Whitney aircraft engines and Collins Aerospace -- are poised to benefit from a multiyear recovery in commercial aviation. Management forecasts that those two business units will drive a marginal profit increase at Raytheon in 2022 of up to $1.4 billion. While there are some risks to the outlook in 2022 -- not the least of which are supply chain issues and the difficulty of replacing components and materials sourced from Russia -- the long-term outlook remains positive. Boeing and Airbus are actively looking to ramp up their aircraft production in response to demand. In addition, its aftermarket revenue is growing.
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On the defense industry side, Raytheon does not expect to see an immediate revenue boost as militaries replace the hardware used in the war in Ukraine. However, CEO Greg Hayes believes there could be "upward pressure on sales guidance" in 2023 and 2024.
It all points to a company with plenty of growth potential, and management continues to target $10 billion in free cash flow by 2025. Based on the current market cap of $143 billion, if it hits that free cash flow target, Raytheon shares today would look like an outstanding value.
Aviation services stock set for growth
AAR provides aviation services (parts and supply, repair and engineering, and logistics support) to the commercial and defense aviation industries, with around two-thirds of its revenue coming from the former. As such, it's a play on the recovery in commercial aviation flight departures as well as ongoing spending on defense. Sales to commercial customers increased 28% year over year in AAR's fiscal 2022 third quarter, which ended Feb. 28.
AAR last reported earnings at the end of March, so it's a little behind most aerospace companies in terms of its reporting schedule (or in front of them, depending on how you look at it). Even so, investors can monitor the situations in its end markets by looking at what other, more significant, aerospace companies like Raytheon and General Electric are saying.
And based on that, the outlook is bright. GE management expects its aviation sales to increase by 20% in 2022, driven by a 25% increase in shop visits (where aircraft receive servicing). Meanwhile, Raytheon's commercial aftermarket sales increased a whopping 38% in the first quarter.
I'm willing to believe that these positive trends will also be reflected in AAR's business. Turning to valuation matters, Wall Street analysts' consensus outlooks are for AAR to deliver earnings of $2.41 per share in fiscal 2022 and $3.28 per share in fiscal 2023. Based on today's share price, that values the company at a price-to-fiscal-2023-earnings ratio of just 14.3.
Image source: Getty Images.
Hexcel is the future of aviation
This company's advanced graphite composites make aircraft lighter and stronger than aluminum. Those are vital considerations for fuel economy and, therefore, for the long-term cost-effectiveness of airplanes, particularly wide-body jets, where weight issues are more impactful.
There's very little aftermarket demand for its products, so the investment case for Hexcel rests on a combination of increased production of aircraft overall, and particularly of newer planes (such as the Boeing 737 MAX and 777X, and the Airbus A320 NEO and A330 NEO family) that have more advanced composites in their structures.
While the timing of the recovery is subject to the abilities of Boeing and Airbus to ramp up their production in the light of ongoing supply chain pressures, the need for increased production is not in doubt. Consequently, Wall Street sees Hexcel growing sales by nearly 20% in 2022 and 14.5% in 2023. Moreover, even when aircraft production volumes eventually plateau, Hexcel's sales should keep growing as newer-generation aircraft become a greater share of those being built.
Wall Street foresees strong earnings and free cash flow growth for Hexcel in the coming years as Boeing and Airbus ramp up production. Free cash flow is forecast to nearly double from $124 million in 2021 to $239 million in 2024. At today's share prices, that values Hexcel at around 20 times its 2024 free cash flow. That's a reasonable valuation for a company with such strong long-term growth prospects.
