Aerospace Cycle Stocks

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A good industry for tough times

This market has been tough; there is no doubt about that. By all estimates (and actual numbers), corporate earnings have continued to improve quarter by quarter since the bottom in March of 2009. Earnings for the 1st quarter of 2009 came in at $7.52, while the most recent quarter earnings for the S&P 500 came in over $22 on the quarter. Those numbers are 3 times higher they were at the bottom in 2009. The P/E (if you multiple the quarter by 4 (4 x 7.52 = 30.08) and then divide it by the S&P 500 level at the time, around 666) back in March of 2009 came in around 22.14. The recent quarter came in above $22, say $22.20 and the market now trades at a 13.21 P/E. The stock market is much more attractive now that it was two years ago…at least on a valuation basis.

By nearly all other metrics: global macroeconomics, GDP numbers from around the world, government policies, government balance sheets, emerging market inflation, and structural unemployment; the world is in terrible shape. The challenge is to find some way to navigate the world of investments until both companies and governments are operating on the same page.

The Aerospace Industry

Until that day comes (if ever), it’s even more important to identify secular trends that will continue to grow (and create wealth), despite the greater macro-economic challenges. Aerospace is one of these themes. Boeing and Airbus have new planes that have dramatically increased the fuel efficiency and capacity over previous planes. It’s necessary for the survival of the airline industry that both capacity and fuel efficiency continue to improve in order for the industry to have some shot at one day operating at a profit. Only Southwest Airlines (LUV) has managed to turn a profit in the industry on a regular basis, with JetBlue (JBLU) behind them in terms of profitable quarters on a regular basis. Both stocks trade for under $10 and have created no real wealth for shareholders over the years.

Invest in the airplane makers, not the airlines

The real way to play the new aerospace cycle (which should last for around 7 years) is with the makers of the planes, rather than with the airlines themselves. If it were possible to invest in the Asian carriers then one might play an actual airline, but since few of us have access to invest directly in Asia, we’ll look at three choices that we can invest in here: SIF, CVU, and BA. 

Company Profile: CPI Aerostructures, Inc.

First up is CPI Aerostructures, Inc. (CVU). The company trades with a current P/E of 53 (which is terrible, most companies that trade with a P/E greater than 20 or so are usually considered “expensive”). But, the trick is to look forward into the aerospace cycle to see where CVU will be. The forward P/E (the price (P) divided by analysts expectation of future earnings (E) is only 6.69. A single digit P/E for us at Magnum Opus Financial, is something worth getting excited about. The historical average P/E of the S&P 500 is 15.17, so when we can buy the stock of a company for less than 10, history tells us that eventually this stock will trade “in line” with the rest of the stock market.

CVU handles the production of structural and other aircraft parts for defense contractors, the United States Air Force, and other branches of the armed forces. It also manufacturers parts for the production of commercial aircraft. The company also has assembly operations, as well as provides engineering, technical, and program management services . The trick for this company, in the face of government spending cuts, will be what percentage of their revenue will come from the private sector (versus their revenue percentage coming from government work). To find out, you’ll want to go to CVU’s website (http://www.cpiaero.com/home.php) and do some homework. Listening to the most recent, or upcoming conference call or calling the investor relations department with this or other questions is a good way to find out. The stock is only $1 off its 52-week low entering the beginning of the latest aerospace cycle.

Company Profile: SIFCO Industries

Next up is SIFCO Industries (SIF). This stock trades with a P/E of just over 13 and has $1.23 in cash. They have 3 times the cash on the balance sheet than debt. SIF operates in three segments: Aerospace Component Manufacturing Group; Turbine Component Services and Repair Group; and Applied Surface Concepts Group. The Aerospace Component Manufacturing Group segment manufactures original equipment manufacturers (OEM) and aftermarket components for aircraft and land-based turbine engines; structural airframe components; aircraft landing gear components; wheels and brakes; critical rotating components for helicopters; and commercial/industrial products. This segment also provides heat-treatment, surface-treatment, non-destructive testing, and machining services for forged components. The Turbine Component Services and Repair Group segment involves in repairing and remanufacturing small aerospace turbine engine components; performing precision component machining; and applying high temperature-resistant coatings to turbine engine components. The Applied Surface Concepts Group segment provides surface enhancement technologies. This segment's principal product offerings include metal plating solutions and equipment required for selective electrochemical finishing; and electrochemical finishing contract services for repair, refurbishment, and OEM applications.

SIF should have much less exposure to government spending than CVU (because they have much less of a focus on the military segment of aerospace). The addition of the services business from the Turbine Component Services & Repair Group, as well as the Applied Surface Concepts Group means that SIF drives revenue from ongoing services (as opposed to just supplying parts for the building of aircraft). Service businesses are like annuities to companies. The key is to achieve the largest installed base of products (turbines in this instance) possible so that management can determine the amount of predictable service revenue that can earned over a particular quarter or year. Don’t forget to do the same homework with SIF. The company’s website is located at Sifco.com.

Company Profile: Boeing (BA)

Finally, the plane maker themselves, Boeing (BA). Companies like MacDonald Douglass, Airbus, and Boeing actual make the airplane (with help from the part/component makers). Boeing actually pays a 2.5% dividend while you wait for the story to play out. Be aware that BA does have a large exposure to military business as well; but, their new Dreamliner should provide years of new revenue for the company now that the plane has been approved to fly. BA also trades with a P/E of about 13.5 with $11.80/share in cash. They have only 1.33 times the amount of cash in debt on the balance sheet. We don’t get concerned until that leverage ratio is closer to 1:6 or 1:7 as long as the revenue and free cash flow is there to support the business and service the debt. With the new Dreamliner getting ready to start shipping, cash flow shouldn’t be an issuing with BA for a few years. The company’s website, for homework, is Boeing.com.

In addition to outright owning BA stock, there are other ways to play this name via options. The January 2013 strike calls are $25.45 for the 40 strike call and $17.70 for the 50 strike calls. This will give you the right to own 100 shares of BA at either 40 or 50 depending on how in the money (ITM) you want to be (and how much capital you’d like to use). Now, in this market, playing without protection (a hedge) is like being in the air 400 feet up, on a burning rope, with no net…not something that seems appealing to us. The January 2013 65/55/45 put butterfly is only $1.50. This structure will give you a long 65/55 put spread and a short 55/45 put spread. The 55 level is where BA traded down to when we hit the lows of the year, so you’ll need to see selling worse than that before you get too concerned about this trade. You only need BA to go up by $1.50 in order to pay for your hedge. Both trades are for the January 2013 expiration, so you have months before you have to make a decision (even if the stock does trade down). Neither of the other two stocks (SIF or CVU) have options on them, because they have very small market caps (number of shares times the price per share will give you the market cap. of the company).

While it’s certainly possible that stocks will get cheaper, opportunities are out there for those who are willing buy now, and then wait for better days. You are protected even if the stock declines by nearly $10 (down to that $55 level) thanks to the put butterfly. Good luck trading. If you want a more active style of trading, you can join us at our new online community at NWATrading where we have traders in our Chat Room every day to answer questions and call out trades for active traders. We are also developing an educational offering for traders who are new or new to options. Thanks for joining us and we’ll see you there!