Lichtwolke
Investment Thesis: Hexcel will recover when aircraft production recovers through 2025. It will grow with steadily increasing margins.
Hexcel
Hexcel (NYSE:HXL) was founded, after World War II, producing six-sided honeycomb metal products that are strong but have low weight. Today. it produces composite materials for three primary markets: Commercial Aerospace, Space and Defense, and Industrial. It evolved into the largest supplier of composite materials for the aerospace market.
Commercial Aerospace represents 57% of its production. It sells to lower-tier suppliers of both Boeing (BA) and Airbus (OTCPK:EADSF). Some aircraft may have composite components from 10 or more suppliers that use Hexcel materials.
Hexcel’s CEO described the third quarter as “strong”. Investors who focused on revenue and cash flow were underwhelmed. He compounded the problem by describing future programs that marketing is currently working on to gain a position on the project but where production is years away. Hexcel faces a market recovery that will stretch through 2025 for existing products.
The following chart lists the sales of Hexcel for nine months along with their growth from the previous year and the projections for full-year growth in 2022 and 2023.
Hexcel Revenue
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Commercial aircraft sales in the first two quarters of 2022 grew by 48%. With delays in production, growth in the third quarter dropped to 25% for an average growth of 40%.
Commercial Aircraft Production
The CEOs of Boeing and Airbus are both very frustrated by the inability to get engines. Both have had to cut production this year. Boeing and Airbus both rely on CFM a 50/50 joint venture between General Electric (GE) and Safran (OTCPK:SAFRF). Airbus also uses the Pratt & Whitney (RTX) geared turbofan. Both engine producers have a plan that should provide adequate engines in 2023. However, neither producer has met their goals in the past and neither producer casts the blades needed for these engines.
These blades are designed to be exotic so engines can operate at high temperate to increase fuel economy. Production of these blades is the pacing item for commercial aircraft production. When blade production restarted after the pandemic with new people the results were horrible. Boeing wants to go from 31 aircraft per month to 38 aircraft to 44. However, they could not get enough engines for 31 planes in 2022. Airbuses’ growth plans are even more ambitious but without the turbine blades, this can’t happen. The CEO of Airbus complains that he is getting pressure to divert spare parts for engines being overhauled by airliner who can’t get the parts to get their planes back in service. There is a major roadblock with these components. Neither aircraft producer has a firm schedule for 2023. The industry is convinced that more engines will be available in 2023. They just don’t know how many. It is likely that the supply of engines will be constrained in 2024.
In Boeing’s case, they delivered 411 aircraft in the first 11 months of 2022. That was an increase of 109 aircraft over the prior year. Some of these airplanes were the 787 and 737 which needed to be modified to meet FAA standards. In November, Boeing delivered 6 787 but production is still at one plane per month which will increase to five sometime in mid-2023. So, the actual number of new aircraft produced is less than 411.
The last normal year of Boeing production was 2018 when 806 aircraft were built. The 777X will not enter service until 2025 because of extensive FAA certification requirements. Before 2025, a low-level of 777 freighter will be built. The good news for Boeing is that Congress in its omnibus bill allowed Boeing to produce the 737-7 and the 737-10 which were delayed by the FAA.
Airbus is close to beginning production on the new A 321. It has a large backlog of A 320 Neos and production of the A 220 will be accelerated in 2023. In 2022, Airbus was unable to deliver its planned aircraft shipments because lack of engines, but still they produced 565 aircraft- 47 more in 2022 than in the prior year. The production of A350s has reached the planned 10 per month level. This aircraft uses more Hexcel content than any other aircraft. Hexcel has extensive production facilities in the EU.
Hexcel sales for business jet production increased 67% in 2022 although this is a small part of Commercial Aerospace. The production of commercial aircraft will not be driven by demand until after 2025.
Space and Defense
The Space and Defense market is stable at about $450 million. 45% of this market is rotorcraft. Bell, a subsidiary of Textron (TXT), received a contract that was headlined as a $70 billion deal for the LRAA (long range assault aircraft). This is good news for Hexcel, but volume production will not start until 2030. Another helicopter, the FARA (future armed reconnaissance aircraft), will be two years later. So, this segment will not change very much in the decade.
Industrial
The industrial market is 25% wind turbine blades. Wind turbines are a declining market for Hexcel. Industrial includes other items such as sporting goods and automotive accessories.
Gross Margin Improvement
The gross margin for the last three quarters of 2022 was 22.5%. For each 20% growth in sales, the previous margin will increase by four percentage points. It is this continual growth in the margin that makes Hexcel so valuable. Full-year earnings per share would be $1.35 To $1.45.
Valuation
In the first nine months of 2022, earnings per share were $1.06 compared to a loss in the prior year of three cents. This illustrates the combined value of high revenue growth and improved margins from improved capacity utilization. Hexcel has been very disciplined about operating expenses. In the first nine month of 2022 revenue was up 19% but operating expense increased only 3.5%, So 2023 increase sales and lower cost per unit should result in in earnings per share of about three dollars per share in 2023. A $1.40 per share at the current PE ratio of 47 would result in a stock price of $66. In 2023, revenue and gross margin improvement would produce about three dollars per share and a stock price of $140.
Risk and Opportunities
The biggest risk is lower volume of Commercial Aircraft production from lower aircraft production. Also operating expenses could increase faster than in 2022.
The Opportunity would be higher volume.
Conclusion
The Commercial Aircraft market should be in a high growth phase through 2025. This makes a company with unused capacity a strong buy.
Editor’s Note: This article was submitted as part of Seeking Alpha’s Top 2023 Pick competition.
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