Bombardier: Compelling Option in Aerospace Sector

Investors who look at the aerospace industry have a difficult choice: Try to cash in on the higher earnings that come from rising defense spending and more demand for civil aerospace, or avoid the sector as soaring fuel prices lead to major capacity reductions by airlines and may cause aircraft delivery deferrals and cancellations.

While oil-induced financial woes may force major U.S. carriers to postpone their fleet renewal plans, 90% of the industry backlog comes from “healthier” non-U.S. carriers, Scotia Capital’s Carlos Gomes says in a new report. The economist also notes that new planes are at least 30% more fuel-efficient than older models, which will be a key factor in renewing the aerospace industry’s financial health. This is evident in the 43% year-over-year gain in orders for fuel-efficient aircraft through May 2008, after hitting a record in 2007. Boeing Co. (BA) and Airbus SAS have a whopping order backlog of more than 7,000 planes.

Mr. Gomes also notes that the global aerospace sector’s strong earnings reflect the fact that commercial aerospace is a late-cycle business. He told clients:

While many S&P 500 companies have reduced guidance in recent months as the U.S. economy has lost momentum, earnings for aerospace companies will accelerate over the next several years as aircraft production ramps up.

In terms or return on shareholders’ equity [ROE] for aerospace stocks, this number climbed to 26% in mid-June, compared to slightly above 18% a year earlier and more than double that of the broader S&P 500.

Montreal’s Bombardier Inc. (BDRAF.PK), the leader in the business jet market with a 20% share, is cashing in on industry shipments that surpassed the 1,000 unit mark for the first time ever in 2007, Scotiabank says, adding that 2008 should be even better. Bombardier had a record 452 business jet orders, a 64% gain from 2006.

Despite the link between a weak economy, corporate profits and business jet demand, the industry has a backlog of more than two years and its orders are less exposed to U.S. customers than in the past, the report said. Bombardier, for example, relied on U.S. orders for 70% of its total sales, but that has fallen to 30% with more coming from Asia and Europe.

So while the pressure of rising fuel costs appear to remain firmly in place, healthy trends in the aerospace sector give investors a compelling option in volatile markets.