2 aerospace stocks I’d buy

Despite the pandemic’s effect on civil aviation, Jay Yao writes why he’d buy aerospace stocks Rolls-Royce and Lockheed Martin.

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Aerospace is a huge industry that’s expected to grow substantially over the next few decades. With long-term trends such as increasing incomes, demand for civil aviation could increase as more people can afford to fly.

Given the continued development of technology, new markets such as space travel could potentially open up further for leading aerospace companies as well. Given the long-term growth prospects of aerospace, I’d buy and hold two aerospace stocks, Lockheed Martin (NYSE:LMT) and Rolls-Royce (LSE:RR).

A leading military aerospace stock

Making the world’s most advanced fighter jets at scale is one of the toughest things to do. It takes decades of research and development to come up with the necessary technology to make jets like the F-35 or F-22. It also takes decades of manufacturing experience to make those jets in a dependable and economical manner. Given the huge difficulties, Lockheed Martin has a very wide moat, which I think makes it an attractive stock.

Given how important defence is to the US and other countries, Lockheed Martin also has a huge backlog and a degree of stability that many other companies don’t have. In terms of its 2020 performance, for example, Lockheed Martin increased its backlog by around $3.2bn to close at around $147bn. In a year where many aerospace companies saw their sales decrease substantially, Lockheed Martin reported record revenue of $65.4bn and record segment operating profit of $7.2bn.

The future for Lockheed Martin could be attractive too. With all of Lockheed Martin’s research and development expertise in aerospace, I think the company could one day do well in space too. Given the nearly endless possibilities in space and the company’s moat, Lockheed Martin is a stock I’d buy and hold.

Lockheed Martin has risks if it doesn’t win as many new defence contracts as the market expects in the future or if management doesn’t manage costs well.

A leading jet engine maker

Like many aerospace stocks, Rolls-Royce shares didn’t do very well due to the pandemic. Fewer people flying have led to fewer total engine flying hours, which has led to lower sales for Rolls-Royce’s civil aviation unit.

With the current Covid-19 vaccine roll-outs, however, I think Rolls-Royce’s fundamentals could improve over the next few years as the vaccines eventually take effect. If civil aviation rebounds over the next few years as many expect, Rolls-Royce could potentially generate substantial free cash flow. With the free cash flow, management can pay down debt, pay a dividend, or invest in new growth areas.

Of Rolls-Royce’s future potential growth areas, air taxis propulsion systems may be one of the most promising. Given Rolls-Royce’s R&D expertise and their brand strength in aerospace, I think they could potentially succeed in that market if management makes the right decisions.

With that said, Rolls-Royce is at risk if the pandemic lasts longer than expected due to Covid-19 variants. The stock could also fall if management makes a bad M&A deal or if they don’t deliver the type of earnings the market expects.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Jay Yao has no position in any of the shares mentioned. The Motley Fool UK has recommended Lockheed Martin. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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