The aerospace giant Boeing (BA 0.39%) or one of its key suppliers, Hexcel (HXL 1.31%), for 2023? It's an interesting question because the two companies share a common earnings driver: increasing aircraft production. So which one is the better buy? Here's the lowdown.
The importance of ramping up aircraft production
Hexcel is a manufacturer of advanced lightweight composites used in commercial aerospace, space and defense, and industrial applications (notably in wind energy). Its key end market, representing around 57% of sales, is commercial aerospace, whereby its composites offer a weight and strength advantage over traditional metals used in airplane construction. Weight is a crucial consideration for aircraft manufacturers, like Boeing and Airbus, because it reduces the long-term running costs of an aircraft. Less weight means lower fuel requirements. Since there's very little aftermarket demand for its composites, the critical drivers of Hexcel's earnings are:
- Increased aircraft production at key customers Boeing and Airbus
- Increased production of newer models, which tend to have more composite content per plane
- Increased production of widebody aircraft, which tend to have significantly more composite content than narrowbody aircraft
Ramping up aircraft production is also critical to Boeing's prospects. Boeing's management sees Boeing Commercial Airplanes (BCA) generating $9 billion in operating cash flow in 2025 and 2026 compared to just $3 billion at Boeing Global Services (BGS) and $2 billion at Boeing Defense, Space & Security (BDS).
BCA will only get to these cash flow levels if it meets management's goals to ramp up 737 production from a rate of 31 a month to 50 a month and 787 production from five a month in 2023 to 10 a month. Increasing volumes is not only crucial for revenue, it's also a large part of how BCA grows margin -- more volumes tend to lead to a lowering of unit production costs.
All told, it's clear that Hexcel and Boeing need aircraft production to increase -- something Boeing and Airbus are desperately trying to do, given their multiyear backlogs.
The investment case
It follows that the case for buying either stock rests on a positive view of the ability of Boeing and Airbus to ramp up production. That argument certainly holds when looking at the potential upside case for each stock. However, investing isn't just about appraising the upside potential; you also have to look at the downside risk. Here, the argument favors Hexcel.
The main downside risk at Hexcel comes from its lofty valuation -- the stock trades at 33 times Wall Street estimates for earnings in 2023 -- and the concern that its industrial-based revenue (about 14% of sales) will drop off in an economic slowdown.
In addition, just as Boeing is struggling with supply chain issues, Hexcel is also battling rising costs. Hexcel's cost of sales rose 13.6% in the first nine months of 2022 to $890 million. Still, they were more than offset by rising sales, and the gross profit margin expanded to 22.5% compared to 18.6% in the same period a year ago. Given improved volumes and factory utilization, margins are likely to keep expanding.
The downside potential at Boeing is more considerable. There are three key considerations. First, its recent history of execution relating to aircraft production leaves something to be desired. If it isn't difficulties ramping up production on the 737, it's been cost overruns and regulatory-required delivery halts on the 787.
Second, Boeing's problems aren't just restricted to BCA. In fact, BDS has suffered multibillion-dollar charges and cost overruns on key fixed-price contracts. While BDS isn't the most significant earnings or cash-flow generator at Boeing, it's important because it helps balance the company in any slowdown for commercial aerospace.
Third, the following chart shows the contrasting movement in each company's debt load. Boeing's debt load could lead to significant problems if anything goes wrong in the next few years.
Data by YCharts
Hexcel or Boeing?
All told, Hexcel looks like the better buy. Both stocks need aircraft production to accelerate, but the downside risk for Boeing looks more substantial than that for Hexcel. As such, the composite manufacturer is the better option for aerospace bulls.
