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Warren Buffett has owned NetJets since 1998, but in 2012 he made an enormous investment so the company could purchase nearly $18B worth of jets. Since NetJets is private, we cannot directly invest in this company. But Todd Hagopian says there are 3 ways we can ride the same trends that Buffett is betting on, with a target return of 50% on each of these investments over the next 2-3 years.
Todd started his Defense/Aerospace Extreme Value fund in March, 2011. His returns have averaged 13.79% since then, which compares to 11.79% for the S&P 500 over the same period. Over the last 3 years, he returned 18.32%, which was better than the top U.S. Equity fund manager. Before taking anyone’s investment advice, you should always check out their track record. Here is Todd’s.
Ken Kam: What trends are behind Buffett’s investment in NetJets?
Todd Hagopian: As I wrote in a previous article, I believe that there is a large disparity between the number of business jets being ordered every year, and the number of jets that will be ordered each year in the very near future. In the 35 year history of the business jet, about 85% of business jet purchases were new airplanes, but now these older fleets are starting to be retired in large numbers for the very first time.
With thousands of corporate jets heading towards retirement, a much more global economy, along with a new generation of wealth hitting the market, Buffett is betting that the rental corporate jet market takes off in the next few years.
Kam: So one trend behind Buffett’s bet is a growing market for corporate rental jets. Are there any others?
Hagopian: Well, Buffett believes that these corporate jet fleets will be retired, and companies will move more towards the rental corporate jet market. He may very well be right, but there are many signs that point towards these aging fleets getting remodeled and sold to new buyers,, and/or getting replaced with new jet fleets. By looking at the trends behind Buffett’s bet, we can identify companies that will perform well no matter how people choose to deal with the retiring corporate jet fleets.
For example, the FAA is predicting $150 oil by 2036, at the same time that they are predicting that Domestic air travel will increase over 50% over that span. That pales in comparison to how fast international air travel will grow over the next twenty years (forecasted to more than double). With all of these predictions, one can bet that more corporations will be relying on corporate jet use in the future, whether they are renting jets, or purchasing new/used corporate jets.
Kam: Predicting the price of oil in 2036 is very difficult. How important is this forecast for your investment thesis?
Hagopian: The reason the longer-term forecasts are so important in this space, is that businesses will be evaluating these potential jet fleet purchases using a 25-35 year life for a business jet. As they make these decisions, they will be looking at 50% more flights in the future, at dramatically higher prices due to the projected increase in oil prices.
The price of oil is not as big of an input as the overall amount of travel that companies will be forecasting over the same time period. Buffett is making his rental corporate jet bet based on the assumption that most corporations run large cost projects using 2-4 year payback calculations, whereas a corporate jet is a 25+ year investment. If key employees are concerned about the trend in business air travel cost/demand, renting corporate jets could be a much easier ROI discussion than replacing a fleet of aging corporate jets for millions of dollars.
There are a few things that are virtually certain though. With Domestic air travel forecasted to rise 50%, and International air travel forecasted to double, there will likely be more aircraft in the skies in the future. As companies put more money into travel budgets, there will be a larger number of companies evaluating the benefits of either owning, or renting, a corporate jet. As companies become more global, the ROI equation on owning/renting a corporate jet fleet will change pretty dramatically. Wall Street is missing this.
Kam: Tell us about Buffett’s investment.
Hagopian: Buffett owns NetJets, a fractional ownership company, which essentially sells shares (or partial ownership) of planes, which allow companies to use private jets without actually having to own and maintain their own fleet.
While Buffett has owned NetJets since 1998, it was not until recently that he made an enormous investment into the company to enable it to purchase nearly $18B of jets in 2012. This catapulted NetJets to the largest private jet fleet in the world, consisting of over 700 private jets with firm orders for over 400 more in its plans. Undoubtedly, Buffett is looking at these same trends, and has made one of his larger bets on this trend magnifying over the next few years.
Kam: Since you can’t follow Buffett by investing in NetJets directly, what are you looking at?
Hagopian: Buffett thinks that all of these trends will add up to an expanded market for rental corporate jets. This could certainly be the way everything plays out. However, there are only a few possible outcomes from these trends:
- Rental Corporate Jet Market Explodes
- Older companies sell their current aging jet fleets to the next generation of companies
- Companies begin replacing their aging fleets with new jet fleets
I will be looking at companies that service existing fleets, companies who sell upgrades to existing business jet fleets (along with new fleets), and companies who will benefit if the new corporate jet market rebounds as well. Basically, I will be targeting companies which will benefit from the broader trend of increased global corporate air travel, regardless of which of these possible outcomes of this trend come true.
Kam: That’s an interesting angle, which is the first company you’d like to highlight?
Hagopian:
Kam: What is the market expecting from ATRO, and why are they wrong?
Hagopian: The analysts currently have a $48 price target on the stock, which would be a 10% increase over today’s price over the next 12 months. The stock has already rebounded 33% over the past couple of months. I think that once this trend really makes itself visible, the analysts earnings estimates will rise, as will the future growth rate, which will allow ATRO to demand a P/E of at least 20, which would translate to around $52, if the company’s current 2017 earnings estimates are understated.
On top of that, I believe that ATRO will be a buyout candidate based on the industry ramping back up, and most of their potential suitors owning multiple businesses that would be aided by acquiring ATRO in the long run. Based on my belief that their acquisition attractiveness will become evident, I am placing a price target of $66 on ATRO over the next 24 months, which would represent a 51% return over that time period.
Kam: What is the second business you would like to discuss?
Hagopian: The second company is
Kam: What is the market expecting from ATRO, and why are they wrong?
Hagopian: The analysts are forecasting a price target of $54, which would only be a 7% increase over today’s price. BEAV just beat earnings handily, and I believe this trend is becoming a reality before our eyes, with the stock already rebounding almost 40% from it’s lows. Owners of older fleets are beginning to sell their fleets to the newer generation of wealth as they upgrade, and this newer generation is not going to want 25-year old seat designs, along with previous generation wastewater management systems in their planes.
As the used market heats up, BEAV will see a healthy increase to its bottom line. My price target for the stock is $86, based on a P/E of 20 and enhanced earnings. This would represent a 24-month return of about 72% over today’s price.
Kam: What is the third business you would like to discuss?
Hagopian: The third company I would like to recommend is
Kam: What is the market expecting from TXT, and why are they wrong?
Hagopian: The analysts are forecasting a price target of $50, which would be a 22% return over today’s prices. Textron recently acquired Able Aerospace Services, which will allow them to make more money on parts, and reduce the lead times of those parts sales. On top of that, they own Cessna and Beechcraft, so they have a huge install base of corporate jets to make money on in the service portion of the business. This company will be well-positioned regardless of whether plane owners hold onto aging fleets, or go back to purchase replacement jets. I have a price target of $62 over the next 24 months, which would represent a 52% increase over today’s price.
Kam: What makes you so confident that this trend will take off prior to a recovery in business jet sales?
Hagopian: Given that many fleets are getting ready to be retired, there will be a large number of companies beginning to do this ROI calculation on how to react to their corporate jet fleet retirement. They will have three possible reactions:
- Replace their fleet with a new corporate jet fleet
- Replace their fleet with a used corporate jet fleet (extending the life at lower cost)
- Decide to use commercial air travel instead of private jet travel
Buffett obviously believes the 2nd reaction is the most likely, which is why he made such an enormous investment in a private company which he has let slowly grow for almost 20 years. I believe that either of the first two reactions are most likely, given all of the factors that will make the third option more expensive moving into the future.
After evaluating projected business jet replacements, projected air travel increases, movement of companies from Domestic to Global focus, and the new generation of wealthy startups entering the market, all of this data backs up the idea that more companies will be making the corporate jet ROI decision in the next 5 years than in any other 5-year period in the history of the industry.
My hypothesis is that companies which service these aging fleets, along with companies that sell interior design elements to the new and aging fleets, will be the first in the business jet segment to prosper from its recovery, followed closely by the companies who sell new business aircraft.
If my projections hold, the three stocks I have outlined will each return more than 50% over the next 2-3 years.
My Take: Todd’s Defense/Aerospace fund has beaten SPDR S&P Aerospace & Defense ETF (XAR) in the YTD, 12 months, and 24 months time frames. Part of the reason is that Todd is not afraid to go after non-traditional investments, such as service-oriented companies, biodefense companies (bought EBS during a huge dip over the summer), and even non-lethal weapon companies (Both TASR and DGLY have returned nicely in the fund).
Todd looks for value in every corner of the Defense/Aerospace industry, and is not afraid to jump onto trends 12 months before others, even if that means he has to wait a little longer to see his returns come to fruition.
To explore whether Todd’s strategy makes sense for you, schedule a One-on-One with Ken Kam.
Disclosure: I am the portfolio manager for a mutual fund advised by Marketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions change.
