Warren Buffett's purchase of Precision Castparts is a $37 billion bet on air travel

With the purchase of Precision Castparts Corp., Berkshire Hathaway's Warren Buffett is wagering that increasing world travel, especially in Asia and emerging markets, will buoy the aerospace industry for years to come.

Airlines have been ordering new planes to meet growing demand for travel and replacing less efficient and less comfortable jets, pushing production backlogs to a record eight years, said Richard Aboulafia, an aerospace analyst with Teal Group, a Fairfax, Virginia-based consultant.

Although the industry goes through cycles and has periods when travel tapers off, such as recessions or following the terrorist attacks of Sept. 11, 2001, plane production has grown steadily over the last half century, Aboulafia said. Precision Castparts, which supplies components such as turbine blades for jet engines and fasteners for airplanes, gets about two-thirds of revenue from the aerospace industry.

"It's hard to see when the good times will end," Aboulafia said. "If you believe in continued world economic growth, continued world trade and continued world travel, then this is as close as you'll get to a very safe investment."

Just as Buffett used the 2010 purchase of BNSF Railway Co., the U.S.'s largest railroad by carloads, as a proxy for growth in the domestic economy, he's banking on global economic expansion with the acquisition of 62-year-old Precision Castparts.

For the past three decades, the industry has been a good bet, said Tom Captain, Deloitte's global aerospace & defense leader. The number of kilometers flown by paying passengers has jumped more than sixfold to 6 trillion now from 900 billion in 1981, he said. That type of passenger growth is expected to continue, he said.

Economic Moat

"It's very clear that the emerging economies and the new wealth being created outside of Europe and the U.S. are driving the travel demand for both leisure and business," he said. "India, China, Indonesia and many of the new-found wealthy countries demand travel."

In Boeing Co.'s annual market outlook, the company said it expects to deliver 13,460 jets to the Asia-pacific region over the next 20 years, followed by North America with 7,550 deliveries. Airbus Group SE, in a similar report, said it anticipates air traffic will grow at 4.6 percent annually, requiring some 32,600 new passenger and freighter aircraft.

The complexity of the components supplied by Precision Castparts to Boeing and Airbus creates an economic "moat" from competition because it's difficult for plane and engine producers to switch companies without risking quality and incurring the cost and delays for certifying new parts with regulators, said Keith Schoonmaker, an analyst with Morningstar.

Entry Barriers

A push by Boeing and Airbus for suppliers to cut prices actually helps expand that moat because Precision Castparts is "the low-cost producer" due to its technology and large volume, said Peter Arment, an analyst with Sterne Agee CRT.

"That fits right into their business model and we've seen that play out for them," Arment said. "There are very high barriers to entry."

The aerospace industry isn't foreign to Berkshire Hathaway. The company owns NetJets Inc., the largest provider of fractional ownership of private jets, and FlightSafety International Inc., which trains pilots, flight attendants, maintenance technicians and dispatchers.

Berkshire Hathaway agreed to pay $235 a share for Portland-based Precision Castparts, valued at $37.2 billion including debt. That's a 21 percent premium over the closing share price on Friday before the deal was announced. Precision Castparts was founded as a way to make a special cutter for chain saw products in 1949 and was spun out into a separate company in 1953.

Production Slowdown

The offer is below the company's peak of $273.99 on July 10, 2014. The stock has struggled after sales to the energy industry fell. Crude oil prices have dropped by more than half after topping $100 a barrel last year.

The growth rate of commercial aircraft production has also slowed every year since 2011 and is expected to decelerate this year to 2 percent before picking up to 5 percent in 2016, according to Deloitte's 2015 global aerospace and defense outlook.

Production for commercial aircraft won't rise forever, said George Hamlin, president of Hamlin Transportation Consulting. The industry has faced unforeseen disruptions in the past, such as the Arab oil embargo in the 1970s and the 2001 terrorist attacks.

"I'm of the opinion that this will be difficult to sustain," Hamlin said. "Sooner or later we will have another recession."

Still, airlines are taking advantage of being profitable after years of losing money to expand and renew fleets, said Howard Rubel, an analyst with Jefferies LLC. The large backlog of orders that Boeing and Airbus have now will keep Precision Castparts busy for several years, he said.

"That provides someone with an enormous amount of visibility on the manufacturing side for the foreseeable future," he said.

-- Bloomberg News

Source: Warren Buffett's purchase of Precision Castparts is a $37 billion bet on air travel