Growing demand for air travel from Asia’s emerging middle class is just one reason to be bullish on commercial aerospace. Investment analyst Todd Saligman shares his outlook for the sector.
Matt Miller: This is a very large area you cover. You've got everything from the Boeings and Airbuses — the kind of aerospace folks. You've got nimbler, smaller airlines like Ryanair and even the defense contractors like Lockheed Martin and Northrop Grumman. With such a big yard, or investment universe, to play in, what has you most excited now in terms of investment themes, looking out, say, over the next five or 10 years?
Todd Saligman: Yeah, you're right: It's a big universe. And it's important to remember that even though all the sectors relate to flying, they're actually all very different. They have different business models, different drivers, different end markets.
The area that I'm most excited about right now is commercial aerospace, and there's really two reasons why. Aerospace is historically a growth industry. Over the last 30 years, passenger travel globally has grown at 5% to 6%, which is two times global GDP.
So it's a secular growth industry historically, but that happened without much contribution from Asia. And as Asia — and China, in particular — as the middle class is emerging in those regions, the first thing people want to do is travel. And so passenger travel in Asia is growing rapidly. There were over 100 million people who flew for the first time in Asia alone last year.
Matt Miller: Last year? Only one year?
Todd Saligman: Last year alone, which is amazing. And when you do the math on the penetration of air travel in China, it's somewhere around where the U.S. was in the 1960s. So, there's a huge — no pun intended — runway for growth ahead from a passenger-travel perspective in Asia. So, that's one of the factors driving aerospace today.
The other one that I'm excited about is, there's a huge replacement demand. The fleet of aircraft flying around the world right now is relatively old. And with new engine technologies that are out, planes are 15% to 20% more fuel-efficient than they were in the past. Even airlines who aren't buying planes to grow are buying them to replace the older planes from a fuel-efficiency perspective.
And so, the combination of those two things is really making the sector an attractive area to invest, I think, now and for the foreseeable future.
Matt Miller: So, on things like the updated engineering that you mentioned, does that mean it's advances in materials science and other stuff that's making it lighter and less costly to operate?
Todd Saligman: Yeah, that's part of it. Part of it is improvements in materials, which make the planes lighter. The other part is the engines in particular, where they're designed more efficiently than they used to be. And as a result, there's a weight reduction in the plane, but there's a 15% to 20% fuel-efficiency increase relative to prior generations. And what's really exciting about it is, in the past, new planes were, on average, 5% to 10% more fuel-efficient. So this generation is really, sort of, a double-generation leap for its history.
Matt Miller: Interesting. Now if we drill a little deeper on Asia — the growth of the Asian market, the way you describe it — what are the investment implications from that? Which of the publicly traded companies that you look at stand to benefit? I know we don't make specific recommendations, but what's the right way to think about some of the firms that you find of interest?
Todd Saligman: I think the direct implication is that there's been huge demand for aircraft from Asia over the last decade. Book-to-bill, which is a measure of the amount of orders relative to production levels, has been higher than 1 in nine of the last 10 years. So in other words, there's been more orders for aircraft than airplanes produced in nine of the last 10 years. And as a result of that, there are huge unfilled backlogs that the OEMs have.
Matt Miller: OEMs are original equipment manufacturers?
Todd Saligman: That’s right. That's Boeing and Airbus. And together they have about 13,000 planes that they have ordered in their backlogs, which they haven't produced yet.
Matt Miller: Wow.
Todd Saligman: So, that's the direct implication. The indirect implication is, one, significant growth for the industry ahead as Boeing and Airbus ramp up production rates to fill those backlogs. And number two, it should make the industry a little bit less cyclical than it's been in the past. You know, in the past, aerospace production rates have gone up materially, and then they've come down. But with the huge backlogs we have today, it should make the industry less cyclical.
Matt Miller: That's striking, the backlog: 13,000-ish of backlog. How many are they producing per year? Is that a multiyear backlog?
Todd Saligman: That's about seven to eight years’ worth of production at current rates, which is pretty amazing if you think about it. There aren't many companies in the world that are effectively sold out for the next seven or eight years, the way Boeing and Airbus are.
Matt Miller: It’s hard to imagine other sectors like that.
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