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The aerospace supply chain has dealt with 737 MAX woes far more effectively than Boeing, and the better relative performance of aerospace suppliers shares attests to their resilience. Now, however, the fallout from the coronavirus pandemic is hitting the sectorand that could create opportunities for investors.
Up until year-end 2019, shares of the aerospace suppliers Barrons tracks rose about 16% since the second fatal MAX crash, on March 10, 2019. That is far better than Boeings performance (ticker: BA), and it outpaces the comparable gains the S&P 500 and Dow Jones Industrial Average.
But since the start of 2020, suppliers stocks have tumbled about 40% as coronavirus fears have grown. (Boeing shares are down more than 50% year to date.) That offers investors a good entry point into these suppliers stocks.
Aerospace is characterized by a handful of highly capable suppliers whose customers include a smaller number of huge companiessuch as Boeingand the U.S. Defense Department. The aerospace supply chain can be visualized as three pyramids: an engine pyramid, an aerostructures pyramid, and a systems pyramid. Plane makers Boeing, along with European rival Airbus (AIR.France), stand at the top of all three groups. Heres a look at some of the suppliers whose valuations have come down, and where they fit in the supply chain.
Engine makers are one level down from the aircraft makers. There are only a handful of companies capable of making engines for large commercial jets. United Technologies (UTX) Pratt & Whitney division, for instance, makes the new, high-tech geared turbofan engine for the Airbus A320 NEO. Safran (SAF.France) and General Electric (GE) make engines for the 737 MAX, as well as other jets. GE and Rolls-Royce (RR.London) make most of the engines for larger, twin-aisle jets. Their engines power planes such as Boeings 787 and 777, as well as the Airbus A330 and A350.
Underneath the engine suppliers are makers of subsystems, including Germanys MTU Aero Engines (MTX.Germany), Americas Woodward (WWD), and Japans IHI (7013.Japan).
Below that trio are suppliers of parts including GKN, which was bought by Europes by Melrose Industries (MRO.London), as well as Mitsubishi Heavy Industries (7011.Japan), among others.
The last tier of the engine pyramid are materials suppliers. Berkshire Hathaway bought a large supplier of forged and cast parts, PCP. Arconic (ARNC), Allegheny Technologies (ATI), and privately held Doncasters supply the industry with high-tech alloys too.
The pyramid visualization, of course, isnt perfect. GE, for instance, bought engine subsystem maker Avio in 2013. GE plays in multiple levels of the supply chain.
Barrons group of engine suppliers is down about 38% year to date and trade for less than 13 times estimated 2020 earnings, down from 17.8 times earnings at the end of 2019.
The aerostructures pyramid has suppliers such as Spirit AeroSystems (SPR) underneath Boeing and Airbus. Spirit, for its part, bakes the carbon composite tubes of the Boeing 787 in giant autoclaves, which are essentially high-tech ovens. The ovens are 120 feet long and 30 feet in diameter. Japans Kawasaki Heavy Industries (7012.Japan) make carbon composite wings for the 787.
Underneath large aerostructure makers come material and fastener suppliers such as Arconic. Modern jets use a lot of composite materials, which are lighter and stronger than comparable metals. Hexcel (HXL), which is merging with Woodward, Japans Toray Industries (3402.Japan) and Cytec, which is now part of European chemical company Solvay (SOLB.Belgium), supply the composites.
Barrons group of aerostructures suppliers is down about 41% year to date and trades for about 13.6 times estimated 2020 earnings, similar to year-end 2019 price-to-earnings ratios. Spirit AeroSystems earnings estimates have come down.
Large industrial conglomerates, such as United Technologies and Honeywell International (HON), reside at the top of the systems pyramid.
United Technologies, through its 2011 acquisition of Goodrich supplies landing gear. Landing gear component suppliers sit below United Tech. And material suppliers feed the component suppliers.
Barrons group of systems suppliers is down about 34% year to date and trades for about 12 times estimated 2020 earnings, down from 17.6 times earnings at the end of 2019.
Aerospace is an oligopolya limited number of suppliers share the market at each level of the pyramid. The industry evolved to this, in part, because of high barriers to entry. Aerospace engineering isnt easy, and it takes a lot to get aerospace parts approved. And in the aerospace business, no onefor the most partwants to buy a spare part from a company that didnt design the original.
The MAX problems didnt create an acute volume crisis for the suppliers. While they had less work because of the MAX, they still had plenty to do.
The coronavirus shouldnt create an acute volume crisis either. Boeing reported minus 28 net orders in February, but the backlog is more than 5,000 jets. Airlines, not aerospace suppliers, feel most of the painthats where volumes can fall hardest, fastest. U.S. airline stocks are down 35% to 55% year to date.
Write to Al Root at allen.root@dowjones.com, follow him @DowJonesAl
Continued here:
Why It Might Be time to Buy Aerospace Supply Stocks - Barron's
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