Aviation Recovery Creates Opportunity for Patient Investors
Airplane replacement cycle should support strong growth as supply chains heal.
November 2023, In the Loop
Air traffic fell dramatically. Airplane production was down significantly. The pandemic hit the aviation industry hard.
Let's talk about the rebound.
The recovery cycle for aircraft parts and equipment suppliers is underway and should play out regardless of economic conditions.
But investing in these companies still requires patience and selectivity.
Let me explain.
Why do I think the growth story in aviation equipment should be durable?
Because it depends on the supply chain recovering and delivering more airplanes to waiting customers.
That’s not easy after so many experienced workers took early retirement or left the industry altogether during the pandemic.
New employees have been hard to find and costly to hire. And it takes time to train them, especially for highly skilled roles.
The industry has also been battered by rising costs. Some suppliers have closed, while others have been reluctant to spend the money needed to scale their operations back up.
Parts shortages, labor constraints, and issues with product quality have kept airplane deliveries at roughly 70% of peak levels.
Why am I confident that the complex aviation supply chain will heal over time?
Demand.
Airlines are eager to replace older plans. New models are much more fuel-efficient and have lower maintenance costs.
The proof is in the orders. The two largest producers of commercial airplanes have amassed backlogs that stretch to roughly 10 years based on their expected production rates.
Even with delivery dates extending well into the future, orders for new planes hit a record high at this year’s Paris Airshow.
But calling the contours of the upcycle in aviation equipment is only half the battle.
The real opportunity is to identify when the market may not fully appreciate a company’s potential to increase its market share or expand its margins.
Here are some of the qualities I look for when evaluating aviation equipment suppliers:
- High-Value Products: Companies with differentiated technologies and strong engineering typically enjoy pricing power and have opportunities to gain share.
- Operational Prowess: Delivering what customers want on time and at the required quality is critical. Seeing the factory floor in action and speaking with workers provide insights into the strength of a company’s operations.
- Favorable Contract Structure: I focus on whether a supplier has the flexibility to pass on higher costs to customers. That’s key to maintaining margins when costs are rising. And it also creates the potential for upside when inflationary pressures recede.
The recovery in the aviation supply chain is a compelling growth story. But it requires some patience. I’ll be looking for long-term opportunities that might emerge from any setbacks that occur as the industry heals.
Key Insights
- The two largest producers of commercial aircraft have amassed sizable backlogs as customers seek to replace aging fleets with new, more-efficient models.
- Equipment suppliers should benefit as supply chains heal and aircraft production recovers, but selectivity will be critical for investing in this area.
- I favor names that have high-value technology, well-run manufacturing operations, and contract structures that allow them to pass along higher costs.
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Transcript
Air traffic fell dramatically. Airplane production was down significantly. The pandemic hit the aviation industry hard.
Let's talk about the rebound.
The recovery cycle for aircraft parts and equipment suppliers is underway and should play out regardless of economic conditions.
But investing in these companies still requires patience and selectivity.
Let me explain.
Why do I think the growth story in aviation equipment should be durable?
Because it depends on the supply chain recovering and delivering more airplanes to waiting customers.
That’s not easy after so many experienced workers took early retirement or left the industry altogether during the pandemic.
New employees have been hard to find and costly to hire. And it takes time to train them, especially for highly skilled roles.
The industry has also been battered by rising costs. Some suppliers have closed, while others have been reluctant to spend the money needed to scale their operations back up.
Parts shortages, labor constraints, and issues with product quality have kept airplane deliveries at roughly 70% of peak levels.
Why am I confident that the complex aviation supply chain will heal over time?
Demand.
Airlines are eager to replace older plans. New models are much more fuel-efficient and have lower maintenance costs.
The proof is in the orders. The two largest producers of commercial airplanes have amassed backlogs that stretch to roughly 10 years based on their expected production rates.
Even with delivery dates extending well into the future, orders for new planes hit a record high at this year’s Paris Airshow.
But calling the contours of the upcycle in aviation equipment is only half the battle.
The real opportunity is to identify when the market may not fully appreciate a company’s potential to increase its market share or expand its margins.
Here are some of the qualities I look for when evaluating aviation equipment suppliers:
- High-Value Products: Companies with differentiated technologies and strong engineering typically enjoy pricing power and have opportunities to gain share.
- Operational Prowess: Delivering what customers want on time and at the required quality is critical. Seeing the factory floor in action and speaking with workers provide insights into the strength of a company’s operations.
- Favorable Contract Structure: I focus on whether a supplier has the flexibility to pass on higher costs to customers. That’s key to maintaining margins when costs are rising. And it also creates the potential for upside when inflationary pressures recede.
The recovery in the aviation supply chain is a compelling growth story. But it requires some patience. I’ll be looking for long-term opportunities that might emerge from any setbacks that occur as the industry heals.
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