An Unstoppable Trend - Three Ways to Play it

A few months ago, I hopped on a train to NYC to check out Gabelli’s 16th Annual Aircraft Supplier Conference. I find these conferences are a great way to learn a lot about the leading companies in an industry in a short amount of time. Among the 14 companies presenting were some industry heavyweights like Honeywell and Boeing.

I have a favorable view of aircraft suppliers in general. And I think this may be a good spot to drop some lines and fish for winners. There are many reasons for my optimism. For starters, the long-term growth trends of air traffic show no signs of slowing down. Since 1977, revenue passenger miles (RPMs) have grown about 5% per year. RPM is an industry measure of air traffic. It is simply the number of paying passengers, times miles flown.

After dipping during the 2008-09 crisis, RPM is on the march again. In fact, it seems to be making up for lost time. More passengers and more miles mean more planes. That’s the simplest reason to like aircraft parts suppliers. Secondarily, the industry retires hundreds of planes every year. And there is renewed demand for more fuel-efficient aircraft.

International Revenue Passenger Miles for US Carries, Dec. 1996 to Feb. 2011

Put it all in a pot and you understand why the backlogs of Boeing and Airbus for new aircraft are very healthy. Over the next several years, these two companies are on pace to deliver more than 1,000 new planes per year. Looking out over the next 20 years, the airline industry as a whole will need more than 30,000 new planes. That’s about $3.6 trillion in new business for the aircraft industry.

The main drivers of all this growth, though, are the billions of new consumers from emerging markets, in particular the Asia-Pacific region. Boeing expects air traffic in the Asia-Pacific region to grow more than 7% per year over the next two decades.

Estimated Annual Growth of Airline Traffic from 2010-2029

So that’s a big-picture view of why I like the industry. As to particular ideas, I’m looking over a bunch: Parker Hannifin, Curtiss-Wright and Hexcel. To be clear, I have not recommended any of these stocks to my subscribers. But I am keeping a close eye on them.

Let’s start with Parker Hannifin (NYSE:PH). It is more of a conglomerate than a pure play on aerospace. Only 18% of sales come from aerospace, but it does so many important things it’s worth talking about. As the senior vice president put it at the Gabelli Conference, “Parker Hannifin is uniquely positioned to address the challenges of mankind.” He then ticked off a list of things including food, water, energy and more. PH essentially makes components to control fluids, hence its broad applicability to everything from water to the fluids of an aircraft.

PH gets more than half of its business from overseas markets. It also gets half of its revenues from aftermarket sales – for things like parts and service. These are stable sources of high-margin business. I like businesses like this.

PH is an old American workhorse whose track record I admire. The company began in 1918 when 33-year-old engineer Arthur Parker rented a loft in Cleveland to develop his unique braking system for trucks and buses. From that humble beginning, PH is a $10 billion business today.

At the conference, PH handed out a pamphlet that showed about a dozen different stats – things likes sales, profits, employees, book value, debt to equity – going all the way back to 1945. Those stats had me floored. You could read a chunk of the history of the nation in these fluctuating numbers, like the width of tree rings serve as a record of the fat years and the lean.

PH has boosted its dividend for 54 years. It has a long track record of steady cash flows. At $87 per share, it trades for about 15 times its 2011 earnings estimate. Analysts are looking for a plump 17% jump in earnings in 2012. International sales account for nearly half the company’s revenue, thereby providing a nice built-in hedge against future dollar weakness. It’s a good company and we may get involved at some point.

Another old American hand I like is Curtiss-Wright (NYSE:CW). The company goes back 80 years when companies created by Glenn Curtiss and the Wright Brothers merged. Lots of people know the Wright Brothers’ story, but Glen Curtiss’ story is less well known. He was a brilliant inventor who brought many innovations to flying.

Curtiss-Wright makes many mission-critical systems for aircraft. It also makes pumps, valves and motors for submarines, aircraft carriers and more. Finally, the company has a good nuclear business in which it makes parts for reactors. In this, Curtiss-Wright is a kind of picks-and-shovels play on the nuclear power.

The company has been growing rapidly of late. Sales have grown 20%-plus over the last five years. Like PH, Curtiss-Wright is another reasonably priced industrial. At the current quote of $33.35, the stock sells for less than 14 times trailing earnings and about 11 times next year’s guess.

Finally, there is Hexcel, which trades on the NYSE under the ticker HXL. Hexcel makes advanced composites made of carbon fibers and glass that make an aircraft lighter, stronger and faster. The company also uses this know-how to make components for the wind power industry.

Hexcel has been growing about 10-15% per year for the last few years. But earnings should grow 20%-plus this year. Hexcel’s composites are popular, given the demands for more fuel-efficient aircraft. The new planes have 10 times the composites of older aircraft. And the wind power business is a growth area, too.

The story doesn’t seem to be much of a secret, though. Hexcel’s shares trade for 16 times next year’s earnings per share guess. But it’s one to watch. I’ll be keeping a close eye on this sector.


Chris Mayer,
for The Daily Reckoning

The Daily Reckoning