2 Stock Picks for Aerospace Investors
Commercial air traffic is coming back, but it's only likely to be in 2023 that global flight departures reach 2019 levels. You can read that statement in two ways. The glass-half-empty view is that the industry has taken a severe hit, while the glass-half-full approach sees it as an industry on the cusp of multi-year growth. I prefer to take the latter view -- and with that in mind, here's a look at why aerospace giant Raytheon Technologies and flight simulator and training company CAE are worth a look for aerospace investors.
The company was created out of a merger between the defense-heavy Raytheon Company and aerospace businesses Pratt & Whitney and Collins Aerospace of the former United Technologies. Unfortunately, the merger took place at the worst possible moment in the COVID-19 pandemic (April 2020). Investors in Raytheon Company must have worried about what they had gotten into by merging with their commercial-aerospace-focused partner.
However, that was then, and this is now. As you can see below, global commercial air flights are growing strongly from 2020, and although they are still below 2019 levels, industry observers expect year-over-year growth until 2019 levels are exceeded in 2023.
As such, Raytheon Technologies investors can expect a sharp recovery in commercial aerospace as aircraft engines need servicing again (Pratt & Whitney) and airplane production and aftermarket services pick up (Collins Aerospace). Meanwhile, Raytheon's defense-focused businesses will provide solid support in earnings and free cash flow (FCF).
Raytheon's CEO Greg Hayes sees the company's FCF recovering from $2.5 billion in the pandemic-hit year of 2020 to more than $5 billion (excluding merger investments) in 2021, and ultimately to the $8 billion to $9 billion discussed at the time of the merger. Wall Street analysts have pegged Raytheon at $7.7 billion in FCF in 2023, and as the aftermarket kicks in, there should be a long runway to growth ahead.
If Raytheon hits analyst targets for FCF, then -- based on its current market cap -- it will trade at 16.8 times FCF in 2023. That's an excellent valuation for a company set for long-term earnings growth from the aviation industry. Given Raytheon's broad exposure to the industry -- from aircraft engines to structures, avionics, cabins, and seating -- it's one of the best ways to play the sector.
Investing in a flight simulator and pilot training company might seem like a tough call, but bear with me. There was a pilot shortage before the pandemic hit, and airlines have been retiring older pilots while holding back on training new ones, so it's not hard to see that the demand for pilots could exceed supply in a few years as flights come back.
That would be great news for CAE -- and it's pretty much the scenario that management envisages. Due to the furloughs imposed on the industry, many pilots have switched to alternative careers, and mandatory age-based retirement remains an issue in the industry.
As such, CAE sees demand for 27 thousand new pilots in 2021 alone. On a more long-term basis, CAE's pilot demand outlook calls for 167 thousand replacement pilots by 2029, with a further 97 thousand required for growth. In other words, 264 thousand new pilots will be needed by 2029. Meanwhile, CAE has an opportunity to benefit from the need to retrain pilots as they prepare to reenter service.
CAE didn't stand still during the pandemic, either -- it inked deals to buy a part of Textron's simulation and training business for $40 million, and announced an agreement in March 2021 to buy L3Harris' military training business for $1.05 billion. The acquisitions will strengthen CAE's military training businesses and further consolidate its leading position in pilot training.
Moreover, CAE has a long-term margin expansion opportunity, taking advantage of its leading position in simulators by growing its higher-margin training revenue.
Putting it all together, Wall Street analysts have CAE's earnings and cash flow bouncing back strongly from the trough in its fiscal 2021. The company is forecast to trade at around 21 times its FCF in March 2024, when global commercial flights should be above the peak in 2019. That's a reasonable valuation for a business with strong long-term prospects.
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Article originally appeared on motleyfool.com
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