If you are considering buying Boeing (BA 0.25%) stock, then you are probably comfortable with the idea that the air travel industry recovery will continue, airplane orders will continue to grow, and airplane manufacturers will be able to execute their multiyear backlogs. Assuming these things might make you favor buying Boeing stock, I think advanced composite materials company Hexcel (HXL -0.03%) is a better investment given these conditions. Here's why.
Boeing has upside potential, but don't forget the downside risk
Despite ongoing difficulties in 2023 (Boeing will miss its initial target for 737 deliveries, and the defense business continues to make losses and suffer charges on fixed-price development programs), management still believes it will hit its target of $10 billion in free cash flow (FCF) in the 2025 to 2026 time frame. As noted, Boeing's current market cap is only about $126 billion, so hitting the $10 billion target would make the stock look cheap.
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That said, Boeing is not without downside risk. There's no guarantee it will hit its target, and as noted above, it's already missed its 2023 delivery targets on the 737, and it's had to take action to help ensure its key supplier Spirit AeroSystems can deliver 737 and 787 fuselages on schedule. In addition, the margin pressure in its fixed-price programs in defense continues to dog the company.
Missing its 2025/2026 targets would create other issues too. For example, Boeing's debt ballooned after the 737 MAX grounding debacle and the travel restrictions imposed during the pandemic, and now stands at $52.3 billion. Failure to hit its cash-flow target would impede its efforts to reduce this debt and also mean it might come under financial pressure in funding the development of a new plane.
Why Hexcel is a better investment
Advanced materials company Hexcel counts Boeing and Airbus as key customers. Hexcel manufactures and sells lightweight composite materials with weight and strength advantages over traditional materials like aluminum. Aerospace is its key end market (including a growing presence on business jets). Its materials help lower operating costs (less fuel used) and enable airlines to meet their emissions aims.
Indeed, Boeing's CEO Dave Calhoun has acknowledged its crucial role in developing new planes. Simply put, Hexcel is a play on the airplane production ramp of airplane manufacturers and the ongoing increase in content per plane as Boeing and Airbus (and others) use relatively more composite content on newer models.
Image source: Getty Images.
There's no debate about the importance of ramping up production for Boeing and Airbus. Not only do they need to deliver on backlogs, but airlines will shy away from placing orders if they see delivery lead times moving out. As such, they will do what it takes to keep on track, even if that comes at the expense of some increased costs.
That's good news for Hexcel and other suppliers because their sales will likely grow in the coming years.
Hexcel prepares for growth
This is not to argue that Hexcel doesn't have its own cost pressures. Indeed, Hexcel's third-quarter earnings report saw the company's adjusted operating profit margin decline, even as sales grew by 15%. However, there's a reason for the decline, and it's a good one. Hexcel is preparing for a 50% increase in narrowbody airplane build rates by expanding its operational capacity, including reopening production lines and hiring/training workers.
While these actions are pressuring near-term margins, they will ultimately improve margins as Hexcel's sales grow and the company benefits from scaling up production. Furthermore, it's not just a question of returning to pre-pandemic levels of revenue (something management expects to do by 2025) because the newer models of airplane produced (including the 737 MAX and Airbus A320 neo) have higher composite content and generate more revenue per plane.
In other words, all things being equal, the growth outlook will be better for Hexcel in 2025 than it would have been in 2019 (the last year before the pandemic) because newer planes generate more revenue for the company.
Image source: Getty Images.
A better buy?
If you want to play the ramp in airplane production, I think Hexcel is a better investment than Boeing. It has less downside risk in case something goes wrong and plenty of long-term upside. Meanwhile, its long-term growth outlook is improving with the industry's increasing use of lightweight composites.
