Profit from pain of air travel

By Robert Walberg

Crowded airplanes are making travel painful this summer. But there's a silver lining for investors: upside potential for shares in the aerospace parts and services sector.

With demand for air travel expected to reach record levels this summer (210 million travelers), according to the Air Transport Association, airlines are trying to squeeze more dollars out of every plane in order to cope with stubbornly high jet fuel prices.

UAL's (UAUA, news, msgs) United Airlines reported that its planes were 89.1% full in June -- a record. AMR Corp.'s (AMR, news, msgs) American Airlines, Continental Airlines (CAL, news, msgs) and US Airways (LCC, news, msgs) weren't far behind with load factors of 87.1%, 85.7% and 85.3%, respectively. A decade ago, the industry average was about 65%.

Meanwhile aerospace parts and services companies are flying under the radar of the financial media. Precision Castparts (PCP, news, msgs), AAR (AIR, news, msgs), Ladish (LDSH, news, msgs), BE Aerospace (BEAV, news, msgs), Rockwell Collins (COL, news, msgs) and Heico (HEI, news, msgs) are up by an average of 58% over the past 12 months.

Count on capacity to grow

Investors are betting on the fact that airline companies can't continue to slash capacity in the face of growing demand for risk of permanently damaging customer relations. It's a good bet. We're already witnessing an increase in capacity among regional/discount carriers, as they fight to win over customers. Once the legacy carriers post a year or two of solid profitability, they are likely to start adding back capacity to meet the growth in demand and to appease disgruntled customers.

The other factor behind the huge gains by the aircraft parts companies is the average age of planes in airline fleets. American, the world's largest airline company, has the oldest, with an average age of 13.3 years. Delta Airlines' planes average 13.1 years. Of the long-haul carriers, only Continental's fleet, at 8.5 years, averages in the single digits.

In addition to having to eventually bolster capacity, airlines must also replace aging planes, a costly but necessary decision likely to come sooner rather than later. Though airlines would like to put off the added cost as long as possible, safety and fuel efficiency demand relatively quick action.

• Get free, real-time stock quotes on MSN Money

Then there's the growth in international demand for planes, especially in Asia, where demand for new aircraft and capacity is expected to continue growing at above industry rates for years. Domestic carriers are also bolstering Pacific Rim routes due to increased demand and relatively high profit margins.

The obvious way for investors to play the need for added aircraft is to buy shares of Boeing (BA, news, msgs), the world's largest producer of commercial aircraft. However, while Boeing's shares have advanced smartly over the past two years (up 48%), they have lagged well behind the less-well-known parts makers -- the listed companies above have gained an average 159% (!) over two years. Meanwhile, the parts makers also sport operating margins that average twice Boeing's, with comparable valuations -- averaging about 20 times current-year estimated earnings.

So if an investor wants to make a play on the long-term need for newer, more-fuel-efficient planes and added capacity, the best bet is to stick with the aerospace parts and services stocks. Of these, Ladish, Rockwell Collins and AAR offer the best combination of growth and value. I'll add shares of all three to my Street Patrol tracking portfolio in MSN Money's Expert Picks section.

At the time of publication, Robert Walberg did not own or control shares of any company mentioned in this article, but his clients owned shares of Ladish, AMR and Boeing.