Despite a 2020 that the aerospace sector would like to forget, there are reasons to be hopeful. Aviation professionals can take solace in the past performance of the aviation industry and the expected turnaround which will inevitably occur in the market. After a steep decline following the March 2020 COVID-19 related shutdowns, the aviation industry started the slow climb to normalcy in May. While there remains significant potential for growth to reach past air traffic demand, air travel has rebounded from the April lows and has shown steady improvement as illustrated by the graph below. The road ahead will not be easy in the near term. Government intervention and the expanding list of approved vaccines have offered a ray of sunshine along the journey and have girded the aviation industry for future growth.
Gap Between Pre-COVID and Current Levels
The chart above depicts travelers’ throughput in the United States as measured by the Transportation Security Administration (TSA) since March 2020. Although there was a significant rebound from the lows immediately following the strict lockdowns, travel throughput remains off 60-70 percent from 2019 levels. The road to recovery has begun but stalled at levels significantly below past performance. Over the next several months, the aviation sector has to draw billions of passengers to return to pre-COVID levels.
Stock Market Boost for Vaccines
In late Q4 2020, we reached a turning point whereby the levers shifted and the aviation industry received a huge boost from the announcement that Moderna and Pfizer received FDA approval. In the U.S., according to the Centers for Disease Control and Prevention (CDC) over 66.5 million doses have been administered and 19.4 million Americans have received two doses as of Feb. 25. Vaccine production and rollout are driving more optimism.
In November, as news circulated that the Pfizer and Moderna vaccines were close to receiving FDA approval, the public market realized the game-changing potential of these vaccines. Stock price performance for aerospace companies increased significantly in the fourth quarter. Per the chart above, the aerospace composite increased 38 percent in the fourth quarter. Investors purchased shares in advance of the actual FDA approvals of the vaccines which were awarded Dec. 11.
Air Traffic Growth Accelerates During an Economic Recovery
As the chart below illustrates, historically, air passenger traffic rebounds quickly following economic shocks with the largest percentage growth gains experienced on the heels of major downturns. However, given the magnitude and nature of the latest event, there are no easy predictors based on past occurrences.
The data over the past twenty years indicates that there is a moderate to strong correlation between GDP and air passenger growth. During the 2000’s, the economy and air travel had to confront the challenges wrought by five major factors:
- The 2001 U.S. recession
- The 9/11 terrorist attack
- The Afghanistan conflict
- The Iraqi invasion
- The SARS epidemic
Air passenger growth declined in 2001 and 2002, while experiencing modest growth in 2003. These five factors weighed heavily on the commercial aviation market, impacting passengers’ health and safety concerns and hindering passenger growth.
Latent demand coinciding with relative peace and prosperity began to yield unprecedented growth in 2004, and would propel the industry for the next several years. With the disappearance of SARS and measured stability in Afghanistan and Iraq, travelers leapt into the relative calm with global air passenger growth of 13.5 percent alongside global GDP growth of 4.4 percent. Air traffic passenger demand increased on average 5.4 percent for the next three years.
Then, the Global Financial Crisis hit and reverberated worldwide, with the U.S. GDP declining -0.1 percent in 2008 and -2.5 percent in 2009 and global GDP dropping -1.7 percent in 2009. The recovery began in 2010 with U.S. GDP increasing 2.6 percent and global GDP increasing 4.3 percent. In 2010, air passenger growth was 16.8 percent and ushered in almost a decade of above-average air passenger growth before the COVID-19 pandemic caused a global shut-down in March 2020. As the 2010 peak illustrates, pent-up demand resulted in significant growth immediately following the crisis.
Latent demand exists now as it almost always does during bleak economic periods. Anecdotally, I have had conversations with friends who are wistfully planning their next vacation to a Caribbean isle to lose themselves and rejoice in the containment of COVID-19. I have also participated in many discussions with business travelers who normally rack up flight miles meeting with clients, prospects and colleagues to chase their business objectives. Without any doubt, the sector will experience another surge in air traffic due to the early impact of latent demand actually materializing. In the past, this growth has been material and contributed significantly to the gains realized post-downturn.
Increase in M&A Activity may Prelude Stronger Recovery
As it became apparent that better days for the commercial aviation industry lay ahead, determined buyers acted in the fourth quarter. The number of transactions increased 70 percent on a quarter-to-quarter basis.
It is important to note that almost half of the deals for 2020 occurred in the first quarter. Following the COVID-19 shut-down and travel restrictions, the commercial aerospace M&A market retreated with only the most resolute venturing into the theater.
Based on the current data points, the range of valuations will reflect the health, stability and growth of the sellers. Aviation companies with significant exposure to military aviation are commanding strong valuations as many acquirers have a stated objective of balancing their portfolio between commercial and military revenue sources. Although the sector has experienced few bankruptcies or dissolutions, such as Impresa Aerospace, many companies are teetering as new relief packages are explored and as Boeing sorts through its challenges, resulting in below-average production rates. Our experience indicates that companies aptly positioned with strong cash flows and the ability to reap the benefits of an uptick in demand command premium valuations during most economic events. On the other hand, current conditions have made it difficult for companies to share their stories and present the messages of growth and prosperity that have long been enjoyed.
The Aviation Sector is Resilient
The chart above overlays Boeing’s stock price over the S&P 500 with noted milestones. Boeing is a bellwether stock for the aviation industry. First, please note that Boeing’s performance over this 25-year period exceeded the S&P 500. Boeing’s stock price increased 830 percent, while the S&P 500 increased 751 percent. Second, Boeing’s performance after the Global Financial Crisis until the COVID-19 pandemic reflected the high rate of growth in air travel and the relative calm and stability experienced in the aviation industry during the last decade. Third, from 2013 to the emergence of COVID-19 in March 2020, despite the grounding of the 737 Max and the 777 Pratt & Whitney engine issues, Boeing had significantly outperformed the S&P 500.
The aviation sector has displayed resiliency over the past 25 years after each financial, economic and health crisis. While the future has yet to be written, one must believe comparable results of resiliency and growth lie ahead.
Warren Romine is a managing director with KippsDeSanto & Co.and co-leads the Aerospace & Defense practice. Romine has over 20 years of M&A experience and is a graduate of Harvard Business School.
