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These Small Caps Are Just Kicking Off a Major New Rally

By Larsen Kusick, analyst, Phase 1 Investor
Friday, June 24, 2011

The aerospace sector is showing classic signs of "relative strength."
 
Growth Stock Wire readers know to watch for relative strength. When the market hits a rough patch, the stocks that trade flat (or even higher) often become the next group of market leaders.
 
Last year, for example, cloud computing companies sidestepped the summer's downturn. From the time I wrote about them through the end of 2010, the five cloud computing stocks I mentioned averaged a 35% gain. The S&P was up only 15%.
 
I think we're starting to see the same kind of move in aerospace. Let me explain...
 
As you know, the market has taken a hit over the last two months. The big-cap S&P 500 index is down about 7%. And almost every sector has seen a drop. Recently, though, aerospace has broken away from the market...
 
The PowerShares Aerospace & Defense fund (PPA) was one of the few to post a solid gain last week, jumping 1.6%. Another big aerospace fund, iShares Aerospace & Defense (ITA), is up 1.5% over the past two weeks, while the S&P is down 1.5%.
 
If the trend continues, it could be huge. You see, the sector is getting a big, long-term boost from newly rich countries around the world.
 
This week's Paris Air Show gave investors an updated look at this new demand. The air show included the "biggest order in aviation history," announced by India's IndiGo Airlines. The company is ordering 180 aircraft from Airbus in a deal valued at $15.6 billion.
 
Russia's UTair Aviation said it plans to buy 40 737s from Boeing. And Copa Holdings, Latin America's fourth-largest airline, said it plans to spend $5 billion buying 62 new planes over the next six years.
 
Other major orders came from Garuda Indonesia, Taiwan's TransAsia Airways, AirAsia, the Philippines' Cebu Air, Aeroflot Russia Airlines, Malaysia Airlines, and Qatar Airways. Even Mongolian Airlines announced an order for three new aircraft.
 
In other words, the flagging U.S. economy isn't affecting the rising global demand for new planes.
 
Last year, Asia's total airline capacity grew 12% and is expected to average 8% over the next two years. The Middle East and Latin America are growing even faster, averaging about 12% and 10% growth over the next couple years, respectively. (The U.S. remains the leader in airline capacity, but it's growing at an anemic 2.5%.)
 
Judging by the media hype, investors are more interested in calling a winner in the battle between the two big plane manufacturers, Boeing and Airbus. But the best way to play the big-picture trend is to bet on the smaller companies that supply these behemoths.
 
It takes thousands of parts to build a plane. That includes everything from the lightweight materials that make up the outside of a plane to the high-tech computer systems used by pilots. And digging into the list of Boeing and Airbus suppliers, I found over a dozen companies that sell parts to both companies.
 
Here are several smaller names that make money off Boeing and Airbus:
 
Company
Market Cap
Expected Annual
Earnings Growth
Forward P/E
Goodrich (GR)
$11.6 B
17%
16.6
Rockwell Collins (COL)
$9.5 B
14%
15.0
TransDigm (TDG)
$4.4 B
22%
22.3
BE Aerospace (BEAV)
$4.0 B
26%
18.8
CAE (CAE)
$3.4 B
15%
17.8
Titanium Metals (TIE)
$3.1 B
46%
25.8
Alliant Tech (ATK)
$2.4 B
-3%
8.4
Hexcel (HXL)
$2.1 B
26%
20.6
Curtiss-Wright (CW)
$1.5 B
13%
12.0
Source: CapitalIQ
 
I expect these companies to have a strong tailwind over the next five years or more. Even better, they're trading at attractive valuations relative to their growth. As you can see in the chart, most are trading at a price-to-earnings ratio in the mid-teens, while averaging double-digit earnings growth over the next couple years.
 
Snapping up shares in these names gives investors higher growth potential compared to buying shares of Boeing. After all, the foreign competitors that are chasing Boeing and Airbus are just as likely to use these smaller companies to supply critical parts.
 
More importantly, the aerospace sector gives investors a chance to avoid some of the effects of a slowing U.S. economy. And with the relative strength, it looks like these stocks are setting up to beat the U.S. market.
 
Good investing,
 
Larsen Kusick




Further Reading:

Larsen is using one company as a "'canary in a coal mine' for the biotech space."
 
He also spotted an interesting setup "in part of the tech sector that most investors never even consider."
 
"We've already seen stocks in some of these companies soar. But the story isn't played out yet."

In The Daily Crux
Market Notes
Oil sinks below $90 for the first time since February.
 
Fear index "VIX" surges 34% this month.
 
Big drugmaker Bristol-Myers Squibb jumps to three-year high on positive drug trial results.
 
Blue chips ExxonMobil, BHP Billiton, Google, and Anheuser-Busch InBev are trading at three-month lows.
Market Watch
Symbol Price
Change
52-Wk
S&P 500 1283.50 -0.3% +17.5%
Oil (USO) 36.01 -2.9% +5.2%
Gold (GLD) 148.34 -1.8% +22.7%
Silver (SLV) 34.37 -3.2% +89.1%
U.S. Dollar 74.86 +0.3% -12.8%
Euro 1.43 -0.7% +15.8%
Volatility (^VIX) 19.29 +4.2% -28.3%
Gold Stocks (^HUI) 514.28 -1.3% +7.3%
10-Year Yield 2.91 -2.7% -6.7%

World ETFs
Symbol Price
Change
52-Wk
S. Korea (EWY) 62.29 -0.2% +31.6%
Taiwan (EWT) 14.84 -0.4% +28.8%
S. Africa (EZA) 68.00 -0.1% +23.4%
Israel (ISL) 16.67 -2.1% +22.1%
Singapore (EWS) 13.31 +0.3% +20.3%
USA (SPY) 128.30 -0.3% +19.8%
Russia (TRF) 20.91 -1.3% +18.2%
Canada (EWC) 30.43 -1.1% +16.2%
Lat.America (ILF) 49.27 -0.5% +13.6%
Japan (EWJ) 10.06 -0.2% +7.2%
India (IFN) 28.57 +0.8% +3.7%
China (FXI) 41.27 +0.4% +2.1%

Sector ETFs
Symbol Price
Change
52-Wk
Oil Service (OIH) 144.48 -0.7% +46.0%
Internet (HHH) 72.96 +0.4% +36.7%
Basic Mat (IYM) 76.54 +0.0% +33.6%
Telecom (IYZ) 24.56 +0.3% +28.3%
Retail (PMR) 20.85 +0.5% +27.3%
Industrials (IYJ) 68.17 -0.2% +26.6%
Transportation (IYT) 96.26 +0.2% +26.1%
Consumer Svcs (IYC) 71.12 +0.2% +24.2%
Biotech (PBE) 22.17 +0.5% +23.6%
Semis (PSI) 16.44 +1.7% +23.6%
Real Estate (IYR) 59.36 -1.8% +23.1%
Health Care (IYH) 73.10 -0.1% +23.0%
Big Pharma (PPH) 70.41 +0.4% +21.6%
Big Tech (QQQQ) 55.34 +0.9% +21.4%
Software (PSJ) 25.62 +0.9% +19.7%
Media (PBS) 14.50 -0.5% +18.9%
Utilities (XLU) 32.70 -0.9% +18.1%
Water (PHO) 18.74 -0.4% +18.1%
Defense (PPA) 19.75 -0.7% +16.1%
Construction (PKB) 12.80 -0.3% +13.6%
Insurance (PIC) 16.09 +0.0% +12.8%
Financials (IYF) 54.66 -1.0% +5.5%
Alt. Energy (PBW) 8.74 +0.6% -1.1%
Nanotech (PXN) 8.36 -0.5% -6.5%

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