Aerospace stocks are rallying with the iShares U.S. Aerospace & Defense ETF (BATS:ITA) up over 15% in the fourth quarter. Is this momentum likely to continue in 2024? Given the solid backlog and improving supply chains, there is potential for more gains.
While the industry has had a record backlog, it has also had a challenging environment. Throughout 2022 and even 2023, the industry has been severely constrained. Particularly, it has faced supply chain problems that have led to lower production numbers.
Slowly, these constraints are getting resolved, and the industry is ready for more growth. Furthermore, demand is robust due to several secular tailwinds. First, commercial aviation continues to be a growth market. Airlines are boosting capacity and ordering new fuel-efficient jets.
Secondly, defense spending is increasing and set to grow over the next decade. Countries, especially European nations, are increasing military budgets as the geopolitical landscape gets more volatile. For instance, Ukraine’s military budget increased six-fold in the 2021-2022 period.
As top spenders like the U.S. government increase their military spending, these aerospace stocks are well-positioned to benefit. Furthermore, the backlog for commercial aircraft is at records. As supply chain bottlenecks ease and production ramps up, these stocks will win.
Boeing (BA)
Boeing (NYSE:BA) is finally putting the 737 MAX problems in the rear-view mirror. As production ramps up, it’s one of the best aerospace stocks to buy. Next year, the China market could provide the next catalyst for more upside in the stock.
With a backlog of $469 billion, including over 5,100 commercial planes, demand has never been stronger. Commercial aircraft deliveries have increased in 2023, but the Chinese market is still challenging. Although China has allowed grounded 737 Max planes to return to service, it has not lifted the freeze on new ones.
However, the ban could be lifted soon, boosting orders in 2024. According to news reports, China is considering allowing Chinese airlines to restart purchases of the 737 Max. This could mark the end of a four-year ban in place since 2019.
As Boeing awaits China’s approval, it has increased production capacity and deliveries. In November, it delivered 56 commercial airplanes, the highest pace since June. 45 of these were 737 Max planes.
Analysts at Baird expect the pace of deliveries to increase in 2024. They see a rapid liquidation of 787 and 787 Max aircraft in storage. In addition, they see an increase in the output of 787 Dreamliners.
Overall, demand is still resilient, as the recent Lufthansa order showed. However, the main catalyst for BA stock will be improving free cash flow as it increases output. Early signs indicate output is ramping up and could grow substantially on China approval.
Heico (HEI.A, HEI)
Heico (NYSE:HEI-A, NYSE:HEI) is a major aircraft-parts manufacturer that produces over 100,000 parts. It operates in a heavily regulated market that requires Federal Aviation Administration (FAA) approvals. As a result, it has significant pricing power and generates tremendous free cash flow.
On December 18, the firm reported excellent Q4 fiscal year 2023 results, highlighting the strength of the business. For the quarter, consolidated organic net sales grew 12% year-over-year. After considering acquisitions, net sales grew 54% to a record $936.4 million. Meanwhile, consolidated operating income increased 29%.
Diving into the segments, the Flight Support Group saw a 74% increase in sales to $601.7 million. This reflects $185.7 million from the acquisition of Wencor and 20% organic growth YOY. The second segment, Electronic Technologies, achieved record revenues of $342.5 million, representing 28% growth. Acquisitions added to the growth, with organic growth up 6%.
Heading into 2024, management expects revenue growth from FY2023 acquisitions and solid demand. They see commercial aviation and defense end markets holding up well. Furthermore, Heico has introduced some new products that will support growth.
Finally, HEI stock is a unique investment among aerospace stocks due to the solid family control and owner-oriented management. The Mendelson family has a controlling stake and runs the business with a long-term focus. The company will continue its history of making accretive acquisitions to compound long-term cash flow.
Textron (TXT)
Textron (NYSE:TXT) stands out as a bargain among aerospace stocks. It is an aerospace and industrial company famous for producing Cessna, Beechcraft and Bell helicopters. The company is seeing revenue growth reaccelerate as demand surges.
In September, Textron got a major boost after signing a significant aircraft deal with NetJets. The agreement gives the Berkshire Hathaway (NYSE:BRK-A, NYSE:BRK-B) subsidiary the option to buy over 1,500 additional Cessna Citation, Latitude and Longitude jets for the next 15 years. According to Jefferies, the deal is valued at about $30 billion, a huge win for Textron.
On October 26, the company reported third-quarter results highlighting the ongoing strength in aviation. Revenues for the quarter were $3.3 billion compared to $3 billion in the prior year quarter. The Textron Aviation segment was the standout, delivering 14.6% YOY growth.
The segment saw strong demand across jet and turboprop products. “At Aviation, we saw our strongest order quarter of the year with a 12% increase over the third quarter of 2022,” said Textron CEO Scott C. Donnelly. Moreover, aviation’s backlog stood at $7.4 billion at the end of the third quarter.
The healthy backlog bodes well for Textron. For 2023, management expects adjusted EPS to be in the range of $5.45 to $5.55. Based on this guidance, TXT stock trades below 15 times forward EPS, which is a bargain.
On the date of publication, Charles Munyi did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
