The aerospace industry is in recovery mode, and the latest earnings report from Delta Air Lines (DAL -0.22%) helps confirm it. Despite significant ongoing challenges (high fuel costs, labor shortages, and a possible economic slowdown), Delta's management remains in an optimistic mode.
Moreover, management's commentary on the earnings call suggests aerospace-giant Raytheon Technologies (RTX 0.71%), pilot training and simulator company CAE (CAE -1.12%), and advanced composite company Hexcel (HXL 1.50%) have favorable end-market conditions. Here's why.
First, a recap of what makes these three stocks attractive and the critical questions around the investment cases for the stocks. Raytheon Technologies is a $141 billion market cap behemoth in the aerospace and defense industry. Management aims to reach $10 billion in free cash flow (FCF) by 2025. It plans to get there through solid growth in its defense business and a robust recovery in its aerospace business.
Due to unfortunate circumstances (war in Ukraine), Raytheon's defense business may receive additional orders in the future as the U.S. replaces older weapons systems given to Ukraine. Other countries are also stepping up defense spending.
However, the critical questions around its aerospace business relate to the durability of the recovery in commercial-flight departures. (Raytheon's Collins Aerospace is a major provider of aftermarket parts, and Pratt & Whitney provides engine aftermarket parts.) In addition, investors will want to know that airlines are in an excellent financial position to make orders as Collins provides original equipment parts and Pratt & Whitney is a major aircraft engine manufacturer.
For CAE, the key to its growth potential is the training market for pilots. That counts for new pilots and existing pilots needing retraining.
Going into the COVID-19 pandemic, there was already a pilot shortage looming, and events since then have arguably made the situation worse. As air traffic slumped due to the pandemic, many pilots retired early, retrained in alternative careers, or declined to continue training.
However, now that the market is in recovery mode, demand for pilot training has returned strong. As such, the critical question for CAE investors is, what is the capacity-growth outlook for airlines? More flights equal more demand for crew, which equals more need for pilot training.
There isn't much aftermarket for Hexcel's advanced composites, so increased aircraft production is key to the company's long-term growth. In addition, newer aircraft tend to have a higher portion of the content in advanced lightweight composites.
Wide-body aircraft tend to have more of Hexcel's composites on board as fuel economy is more of an issue on larger aircraft. Hexcel's materials are lighter and stronger than alternative materials such as aluminum.
As such, Hexcel investors want to hear that the airlines are growing earnings and placing orders, the wide-body market is recovering, and leading aircraft manufacturers are ramping up production.
Delta gives positive answers
If Delta's management commentary is a helpful guide, then investors in all three companies will be happy. Digging into the second-quarter earnings call:
- Despite cost pressures from high fuel and non-fuel costs, underlying solid demand enabled Delta to increase prices, and operating income was almost at 2019 levels for the second quarter.
- CEO Ed Bastian has "yet to see any meaningful pullback in demand."
- President Glen Hauenstein sees "demand and pricing strength carry into the late summer and fall as demand remains strong."
- Higher-margin business travel and premium products are returning strongly -- good profitability news.
- Delta is only running at 85% capacity, compared to 2019, so there's plenty of growth potential as it ramps up to 100%. Bastian thinks it will be in the summer of 2023.
- Bastian talked of an "opportunity in the next three to five years of delivery for some additional narrow-body, large narrow-body acquisitions" and said, "[W]e have got a pretty healthy stream of widebodies coming."
Simply put, investors in Raytheon, CAE, and Hexcel would have heard everything they wanted to hear from Delta Air Lines. Despite ongoing cost pressures, Delta can pass on costs because end-market demand remains robust. It all points to a continued recovery in airline profitability, flight departures, and aircraft orders. That's great for Raytheon, CAE, and Hexcel.
Stocks to buy
Notwithstanding some weakness in the second quarter from flight delays and cancellations due to reopening stress, the commercial-aerospace industry is in good shape. Therefore, any weakness in these three stocks should be considered an opportunity to buy.