As an investor, imagine if you could invest in an industry that enjoys the pricing power and regulatory barriers enjoyed by tobacco incumbents as well as the growth prospects of high tech? That would be a kind of investment Nirvana, wouldn’t it? Well, it just so happens that such an industry exists, and it is the multilayered aerospace industry.
In fact, while most investment historians are familiar with the fact that tobacco, in market-weighted terms, has been history’s best performer, on an equal-weighted basis (which means component suppliers are represented equally with airplane producers), it is actually the aerospace industry that has outperformed all others, and it has done so on a remarkably consistent basis:
Among the many reasons for this is that aviation has historically grown at a very high rate, by some estimates as high as twice that of GDP. Thanks to rising incomes and innovations such as the Boeing 747, which Bill Gates referred to as the “first world wide web“, affordable air travel became a reality for the masses. Increased globalization in the latter half of the 20th century meant a more interconnected world, and data paint a clear picture: as GDP per capita increases, air travel increases:
Given this dynamic, and the rather surprising fact that an estimated 80% of the world’s population has never flown, the growth drivers for demand in aerospace seem solidly in place.
That being said, growth alone has never been enough to sustain outperformance in a given industry, so what makes aerospace so unique?
For starters, commercial airliners are extremely complex machines with tens of thousands of components. They range from landing gear assemblies and heat shields to safety buckles and luggage compartment fasteners. Because of the inherent risks of flying large jets around the world at 30,000 feet, these parts typically must be certified by regulatory authorities for use on aircraft. Secondly, large passenger aircraft operate in very long product cycles, typically stretching over decades, with mandatory replacement at specific age or usage intervals. These factors, along with the fact that many of the various components involved are not a large percentage of the overall project cost, mean tremendous pricing power for suppliers.
As Eric Ruden of Ironvine Capital put it on an episode of Business Breakdowns on HEICO:
“[Aerospace] is a market with extremely long product cycles. So I think average life of an aircraft is anywhere from 25 to 30 years. The average production run for an aircraft platform is 10 to 20 years. So that gives you 35 to 40, sometimes more, years, too, to be selling parts into maintaining those aircraft, which I think is something that people end up classing over.
When you think 30 years ago, I wasn’t alive, and we are still thirteen years away from the first iPhone, but we are still flying 737s, so a long duration cycle. And then the second most important thing to understand is this is an industry with very high regulatory capture, so the only way that you can sell a replacement part to an airline is if it is approved by the FAA [Federal Aviation Administration].”
The current environment seems especially attractive for suppliers to the aerospace aftermarket. That is because production issues have hampered deliveries of new airliners (via AerCap IR)…
…meaning that the existing fleet of airliners is steadily aging (via IATA):
Putting it altogether, you have what seems like a very attractive set-up: strong, secular growth in air travel powered by increased global connectedness and a rising global middle class, along with attractive industry dynamics enhanced by production bottlenecks for end markets. It certainly seems that the future for aerospace is just as bright as ever.
At time of publication, both the author and clients of Fortune Financial Advisors, LLC own shares of HEICO.
