Precision Castparts Corp.

Transcription

1 February 19, 2015 Precision Castparts Corp. Current Recommendation Prior Recommendation Neutral Date of Last Change 02/19/2015 Current Price (02/18/15) $ Target Price $ UNDERPERFORM (PCP-NYSE) SUMMARY We are downgrading our recommendation on Precision Castparts to Underperform from Neutral following its weak third quarter fiscal 2015 results. Although the company s quarterly earnings managed to surpass estimates, revenues fell behind. PCP was challenged by uneven demand for aerospace engines by a single customer, ongoing uncertainties in the oil & gas market and considerable erosion in the company s military activity. With these factors expected to continue, Precision Castparts projected fiscal 2016 earnings per share to be lower than its previously specified range. In addition, Precision Castparts business is prone to the impact of currency volatility and adverse global, political and economical conditions, since a significant portion of its revenues is derived from non- U.S. markets. SUMMARY DATA 52-Week High $ Week Low $ One-Year Return (%) Beta 0.99 Average Daily Volume (sh) 1,677,252 Shares Outstanding (mil) 142 Market Capitalization ($mil) $29,958 Short Interest Ratio (days) 3.93 Institutional Ownership (%) 89 Insider Ownership (%) 1 Risk Level * Average, Type of Stock Large-Blend Industry Metal Proc&Fabr Zacks Industry Rank * 215 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Jun) (Sep) (Dec) (Mar) (Mar) Annual Cash Dividend $0.12 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 15.0 Earnings Per Share (%) 17.7 Dividend (%) 0.0 using TTM EPS 16.7 using 2015 Estimate 16.8 using 2016 Estimate 14.9 Zacks Rank *: Short Term 1 3 months outlook 4 - Sell * Definition / Disclosure on last page ,970 A 1,931 A 2,043 A 2,439 A 8,378 A ,367 A 2,362 A 2,357 A 2,530 A 9,616 A ,528 A 2,522 A 2,459 A 2,534 E 10,043 E ,580 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Jun) (Sep) (Dec) (Mar) (Mar) 2013 $2.35 A $2.28 A $2.40 A $2.82 A $9.84 A 2014 $2.88 A $2.90 A $2.95 A $3.27 A $12.00 A 2015 $3.02 A $3.24 A $3.09 A $3.23 E $12.58 E 2016 $14.18 E Projected EPS Growth - Next 5 Years % Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 OVERVIEW Precision Castparts Corp. is one of the leading manufacturers of complex metal components and products. The company basically serves the aerospace, power, and general industrial markets. The company has expertise in the development of premium large, complex structural investment castings, forged components, airfoil castings, aerostructures and highly engineered, critical fasteners for aerospace applications. Apart from this, Precision is also known for production of airfoil castings for the industrial gas turbine market. The company also manufactures extruded seamless pipe, forgings, fittings and clad products meant for power generation and oil & gas applications, commercial and military airframe aerostructures and metal alloys and other materials. Precision Castparts has three principal business segments: Investment Cast Products, Forged Products and Airframe Products. Investment Cast Products (accounted for around 25.7% of third-quarter fiscal 2015 sales) segment includes PCC Structurals, PCC Airfoils and the Specialty Materials and Alloys Group (SMAG). These operations manufacture investment castings for aircraft engines, IGT engines, airframes, medical prostheses, armament and other industrial applications. The segment also provides alloys and waxes to Precision Castparts investment casting operations, as well as to other investment casting companies. The company is among the leading manufacturers of Forged Components (41.8%) for the aerospace and power generation markets. Forged Products aerospace and IGT sales are primarily derived from the same large engine customers served by the Investment Cast Products segment, with additional aerospace sales to manufacturers of landing gear and airframes. Similarly, the dynamics of the aerospace and power generation markets, as described in the Investment Cast Products section, are virtually the same for Forged Products. In addition, Precision Castparts manufactures high performance nickel-based alloys used to produce forged components for aerospace and non-aerospace markets, which include products for oil and gas, chemical processing and pollution control applications. Precision Castparts is a leading developer and manufacturer of highly engineered Airframe Products (32.5%) primarily for critical aerospace and automotive applications. The majority of its sales come from the same aerospace customer base already served by Investment Cast Products and Forged Products segments. In this regard, Airframe Products is subject to many of the same market forces as these other two segments. The balance of the segment s sales is derived from automotive and general industrial markets, including farm machinery, construction equipment, machine tools, medical equipment, appliances and recreation. Precision Castparts engineered products, manufactured from a variety of steel, nickel and titanium alloys, are used in automotive applications, including power trains; suspensions; steering, airbag, and seating systems; and chassis assemblies. These products have also penetrated into other markets requiring proven strength, close dimensional tolerance and high reliability, such as diesel, mining, construction, heavy truck and niche general industrial applications. Precision Castparts sells its complex metal components and products into three major market areas: aerospace (70% of third-quarter fiscal 2015 sales), power generation (17%), general industrial and other (13%). Equity Research PCP Page 2

3 REASONS TO SELL Precision Castparts came up with sluggish third quarter fiscal 2015 results mainly hurt by weak performance of its Forged Components segment, which accounts for the largest share of its overall revenues. Although the company s quarterly earnings managed to surpass the estimates, revenues fell behind. The Forged Components segment was largely hit by uneven demand of aerospace engine by a single customer, which weighs down the company s production capacity and inventory level. Also, Precision Castparts quarterly financials negatively affected from the ongoing uncertainties in Oil and Gas market. Apart from this, considerable erosion in the company s military activity added to the woes. Also, due to all these factors, Precision Castparts expects its fiscal 2016 earnings per share to be lower than its previously specified range of $15.50 $ Hence, given these factors, we expect the company s bottom-line growth to remain restrained in the coming quarters. Precision Castparts uses a number of raw materials in its products, including metals such as cobalt, titanium, nickel, tantalum and molybdenum, which are found in only a few parts of the world and are available from a limited number of suppliers. The price fluctuations in raw materials could result in decreased sales and margins, or otherwise adversely affect its businesses. The enactment of new or increased import duties on raw materials could also increase the cost of obtaining the raw materials and might adversely affect its businesses. The company operates in a highly seasonal aerospace and power generation markets. The demand for commercial aircraft is currently being influenced by the impact of terrorism, a changing global political environment, and the U.S. foreign policy. The power generation market is also facing challenges from rising fuel costs, and changing government policies regarding environment control measures imposed on the power generation industry. Precision Castparts business can be negatively impacted if there is a loss of business from any of its major customers. The company derives a significant portion of its revenues from a few major customers like General Electric, The Boeing Company, Airbus, Rolls-Royce and United Technologies. General Electric alone was attributable for as much as 13% of the company s total revenues in fiscal Precision Castparts business is also prone to the impact of currency volatility and adverse global political and economical conditions as a significant portion of its revenues is derived from non- U.S. markets. In 2014, about 19% of the company s total revenues were derived from the non-u.s. markets. Therefore, the business can be negatively affected by the changes in rules and regulations across the globe especially in countries like China where commercial laws and regulations are altered frequently for the foreign companies. The company is also affected by the changes in tax structures and exchange rate fluctuations in the international economy. RISKS Precision Castparts has been experiencing significant growth in its Investment Cast Products segment. Currently, the aerospace market looks promising and is expected to benefit the company s financials going forward. In particular, the company has been experiencing strong demand of IGT aided by the introduction of new products and programs. Precision Castparts further expects its fiscal 2016 earnings to be driven by expansion of its share in the IGT market. Hence, we expect the company s Investment Cast Products segment to continue benefiting its financials. Equity Research PCP Page 3

4 Also, Precision Castparts is continually focusing on expanding its product lines and markets. Some of the company s significant buyouts like ADI, Permaswage, TIMET has been contributing greatly to its growth. These acquisitions are further expected to improve the value proposition for the company s airframe business by expanding its aerostructures product offering and its role on the next-generation aircraft. The company s cash balance improved to $430 million as of Dec 28, 2014 from $361 million as on Mar 30, Hence, we believe Precision Castparts has enough liquidity for both organic growth and acquisitions. Also, the company is dedicated to strengthening its shareholders wealth via dividends and share buybacks. In the reported quarter, Precision Castparts returned more than 1.3 billion to its shareholders in the form of share repurchases. This boost investors confidence in the stock. RECENT NEWS Precision Beats Q Earnings, Lags Revenues on Headwinds Jan 22, 2015 Precision Castparts reported third-quarter fiscal 2015 results, with earnings from continuing operations of $3.09 per share slightly surpassing the Zacks Consensus Estimate of $3.08. Also, quarterly earnings were up 5% from $2.94 per share earned in the year-ago quarter. The year-over-year increase was primarily attributable to the success of the company s aircraft and engines development and production plans. Revenues & Margins Revenues increased about 5% year over year to $2.46 billion from $2.34 billion in the prior-year quarter. The company witnessed 6% growth in sales on the back of productive aircraft and engine contraction programs. Returns accrued from the company s industrial gas turbines trade also supported the yearover-year improvement in gross revenue. However, the top line missed the Zacks Consensus Estimate of $2.52 billion by 2.2%. The revenue estimates suffered a miss due to certain adversities encountered in its trade, such as deferred shipments of the marketable aerospace customers and uncertainties in the oil and gas market. Such issues negatively impacted the company s operating income margin by 80 basis points (bps). Segment Results Investment Cast Products revenues increased 4% year over year to $632 million. The segments demand growth was primarily driven by efficient activities in the industrial gas turbine ( IGT ) and commercial aerospace business segments. Aggregate sales of the commercial aerospace segment climbed 2% on the back of newly developed aircraft engine platforms. On the other hand, growing demand for spares, new manufacturing turbines and upgraded strategic trading programs supported 10% improvement in IGT s sales. Improved revenues from the company s Investment Cast Products business segment helped augment its operating income by 5% year over year. Forged Products sales experienced a marginal year-over-year improvement of 2%. The escalation was primarily attributable to a surplus of $10 million, accumulated from favorable revert and alloy prices. However, expenses related to the de-stocking of a particular aerospace customer, weaker energy demand and deferred shipments lowered the operating margin by 230 bps. Equity Research PCP Page 4

5 Growth of 11% was achieved from sales of the Airframe Products trading division. The significant improvement was driven by 17% growth in commercial aerospace sales. Moreover, resourceful integration of recent acquisitions and rising demand of aerostructures helped boost the segments operating income by 12%. Balance Sheet Exiting the quarter, Precision had a cash balance of $430 million, up 19.1% from $361 million as on Mar 30, The company s total debt level stood at $4.1 billion versus $3.6 billion as on Mar 30, The debt to capitalization ratio increased to 26.0% from 23.9% as on Mar 30, Total capital expenditure incurred in the quarter aggregated $107 million. Guidance Precision expects earnings EPS in the range of $12.80 to $12.90 in fiscal 2015, after considering possible negative effects of the business externalities. However, the company aims to achieve steady growth until the end of fiscal 2016, backed by its IGT market share improvements, superior technological expertise, expansion in aerospace construction, strategic integration of acquisitions and attractive share repurchase programs. Dividend Update On Feb 12, 2015, Precision declared a quarterly cash dividend of $0.03. The dividend is payable on Mar 30, to stockholders of record as of Mar 6, VALUATION Precision Castparts current trailing 12-month earnings multiple is 16.7x compared with the 23.3x average for the peer group and 19.3x for the S&P 500. Over the last five years, shares of Precision Castparts have traded in a range of 15.5x to 23.5x trailing 12-month earnings. We changed our long-term recommendation to Underperform on the stock as we expect it to perform below the broader market. Our target price is $ or 15.3x 2015 EPS. Equity Research PCP Page 5

6 Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Precision Castparts Corp. (PCP) Industry Average S&P Norsk Hydro ASA (NHYDY) AB SKF (SKFRY) NSK Ltd. (NPSKY) TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Precision Castparts Corp. (PCP) Industry Average S&P Equity Research PCP Page 6

7 Earnings Surprise and Estimate Revision History Equity Research PCP Page 7

8 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of PCP. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1126 companies covered: Outperform %, Neutral %, Underperform 7.4%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research PCP Page 8