Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 2Q Fiscal 2016Earnings Update
Previous Edition: Sep01, 2015; 1Q Fiscal 2016 Earnings Update
Brokers’ Recommendations: Positive: 12.5% (2); Neutral: 87.5% (14); Negative (0) Prev Ed.: 5,12, 0
Brokers’ Target Price: $232.17(↓$0.47 from the previous edition, 12firms) Brokers’ Avg. Expected Return:0.1%
Note: A Flash Update on 2Q2016 Earnings was done on Oct22, 2015.
Note: We did not have access to the report from the brokers providing Positive recommendation on the stock
Portfolio Manager Executive Summary
Precision Castparts is a global manufacturer of complex metal components and products that serve a wide variety of aerospace, industrial applications and power generation end-markets through thefollowing segments:Investment Cast Products, Forged Products and Airframe Products.
Trend of Broker Opinions: Broker sentiment on the stock remains skewed toward the neutral side, with 87.5% of the firms rating the stock neutral, 12.5% rating it positive and none of them rendering a negative rating. Target prices provided by the firms range from a low of $220.00to a high of $240.00per share. The average came in at $232.17, implying a positive return of 0.1%.
Neutral or equivalent outlook – (14firms or 87.5%)–On the positive side, these firms believe that bright prospect of commercial aerospace in international markets and strong momentum in OEM markets will prove to be particularly advantageous for Precision Castparts in the long run. These firms believe that future production will remain impressive due to large backlogs at Boeing and Airbus aircrafts, which in turn,should unlock lucrative opportunities for suppliers like the company. Despite the cyclical nature of the global commercial aerospace, these analysts remain confident that the industry is reaching a mature stage, which will be beneficial for the company. These firms also believe that strong generation of free cash flow, robust operating margin, advantage of being a single supplier in multiple markets, and excellent management team remain the company’s basic strengths,whichdrove a firm like Berkshire Hathaway to acquire it. The deal is expected to close by the first quarter of calendar year 2016.
However, weak oil and gas demand, coupled withgeneral industrial trends and weakness in infrastructure spending in key markets, will likely hurt the company’s growth. These brokers anticipate that pressure on oil & gas volume as well as pricing will continue to trouble the company’s financials in the near term. Also, strong currency headwinds andlevel of investment to keep up with new technologies might affect its margins adversely,going forward. Moreover, as the company derives its revenues from a handful of major customers, loss of any one of them will hamper its performance significantly. Other factors like volume leverage, weaker product mix and planned maintenance outages are also weighing on the company’s financials.
Dec08,2015
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 27.8% of second-quarter fiscal 2016 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 ranked among the leading manufacturers of Forged Components (39.6%) 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 (32.6%) 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.
More information is available on its website The company’s fiscal year ends in March.
Key Positive Arguments / Key Negative Arguments- Precision Castparts is one of the best operators in the civil aerospace segment with operating margins are generally higher than its peer companies. Acquisitions are expected to remain a key part of the company’s growth strategy.
- The company offers greater balance sheet optionality than most companies and has a strong M&A track record. It has been experiencing solid contribution from the acquisition of ADI, Permaswage and TIMET.
- Precision Castparts’ strong management, significant incremental market share gains and an ongoing favorable mix shift toward newer-generation aircraft engines help valuation.
- The company enjoys significant exposure in the industrial gas turbine (IGT) market, which is also experiencing OE and aftermarket demand. Airframe segment of the business has been experiencing solid growth as well.
- Precision Castparts remains focused on reducing its costs.Analysts believe management’s emphasis on working capital, cost reduction and manufacturing process improvement will likely deliver margin expansion over the next several years.
- There is a possibility of Precision Castparts failing to sustain its margin expansion achieved despite falling sales and margin reversal. In addition, there are risks associated with the company’s acquisition strategy, some of which include the possibility of overpayment for an acquisition or failure to integrate a business.
- Precision Castparts is subject to substantial competition in all the markets it serves. If the company is unable to adjust costs relative to pricing or fails to continue to compete effectively, its business will suffer.
● Uncertainties in the oil and gas markets remain one of the biggest challenges for the company. Additionally, strengthening of the U.S. dollar continues to act as a drag on its profitability.
Key investment considerations as identified by the analysts are as follows:
Feb 24, 2015
Dec 08, 2015, 2015
Long-Term Growth
Precision Castparts is one of the two principal domestic companies supporting the U.S. Aerospace and Defense Sector, as well as related international clients. The company sources a significant portion of its revenues from its Aerospace business. As increasing percentage of revenuesare accrued from the sector, analysts hope that with a rise in military spending by the government, the company is bound to be benefited.
Going forward, the firms believe Precision Castparts will continue to exploit all opportunities to extract the best possible performance out of its plants, worldwide. Commercial aircraft build rates are being normalized against the order rates, bridging the gap between the two. The demand for fuel-efficient aircraft is likely to increase in the long term, as these aircrafts have the capability of reducing operating costs significantly. Precision is one of the few firms who are engaged in production of the exotic components required for such aircrafts. The increased production of the alloy castings required for these aircraftswill certainly benefit the company’s top-line growth rate, going forward, apart from helping to offset cyclical pressures. The recent aircrafts are more dependent on the specialized components produced by Precision Castparts. Furthermore, increasing global investment in the aerospace infrastructure is likely to benefit the company significantly, fueled by increased demand for its novel products.
At the same time, sales in the IGT and Airframe Products continue to show immense growth. Precision has a strong potential for achieving high revenue growth in the longterm, driven by the use of its jet engine technology for manufacturing the castings required for IGT engines. Demand for this advanced technology is likely to increase as the machines require more replacements due to an increase in power production over the long run. The company continues to seek opportunities throughout its operations in productivity, yields, reduced scrap and rework, and inventory. Based on the demand for requirement of core components in electricity and power grids, the company stands likely to benefit in the longrun. The company believes that Investment Cast Productsis extremely well-positioned to benefit from a strong installed based and growth in high efficiency IGTs.
Given management’s track record of acquisitions, the firms are convinced that any large deal or collection of smaller deals will continue to be accretive to growth. The company has a lower cost structure compared with its peers, which aids its profit margins even with competitively priced products. The company has a strong focus on restructuring activities to generate cost-savings that can support long-term growth. Moreover, the company is taking up multiple internal investments to improve cost management, primarily in aero-structure operations associated with activities in TIMET and Wyman Gordon, which will be conducive to growth.
Precision Castparts’robust financial health and ample liquidity allows it to implement a prudent capital deployment plan, which focuses on two aspects, namely, strategic acquisitions and share repurchase programs to maximize its growth potential as well as shareholders’ value. Over the past 12 years, the company has successfully acquired other firms and integrated them with its core businesses to develop a strong portfolio. Over the next two years, the company aims to close acquisitions worth $3 billion out of its $5-billion plan,aiding its growth. Additionally, Precision Castparts is actively conducting share repurchase programs, which will drive future earnings per share growth.
Precision Castparts disclosed the signing of a merger deal with Berkshire Hathaway Inc. for a transaction value of about $37.2 billion. The deal is expected to conclude during the first quarter of calendar year 2016, upon fulfillment of customary closing conditions. Post completion of the acquisition, the company will operate under the same name across the globe as a wholly owned subsidiary of Berkshire Hathaway. For Precision Castparts, the merger will lead to significant value appreciation for its shareholders and offer strong synergies to better serve its customer needs.
Dec 08, 2015
Target Price/Valuation
Provided below is a summary of valuations and ratings as compiled by Zacks Research Digest.
Rating DistributionNeutral / 12.5% ↓
Positive / 87.5%↑
Negative / 0.0%↔
Maximum Target Price / $240.00↓
Minimum Target Price / $220.00↑
Avg. Target Price / $232.17↓
No. of brokers with Target Price/Total no. of brokers / 12↑/16↓
Risks to the target price include higher oil prices, downturn in commercial aviation and unexpected cancellations of programs in both commercial and military segments.Jun26, 2
Dec 08, 2015
Recent Events
On Oct 22, 2015, Precision Castparts reported second-quarter fiscal 2016 earnings from continuing operations of $2.49 per share, which lagged the Zacks Consensus Estimate of $2.94. Also, the bottom line declined 23.1% on a year-over-year basis.
The decline in bottom line was mainly led by poor top-line performance during the quarter. Moreover, higher interest expense as well as selling & administrative costs dragged earnings. This apart, pricing pressure in the oil & gas market, persistent “fastener destocking” and operational issues in the Airframe Products segment added to the year-over-year fall in earnings.
Revenue
Net sales for the second quarter of fiscal 2016 decreased about 9.3% year over year to $2.28 billion, which fell short of the Zacks Consensus Estimate of $2.48 billion.
The year-over-year decline in net sales was primarily attributed to lower sales from Forged Products and Airframe Products in the reported quarter. Moreover, softness in the power markets, primarily industrial gas turbine (“IGT”) and non-IGT oil & gas and pipe markets, were responsible for the poor top-line performance.
Quarterly Segmental Results
Investment Cast Products sales inched up 0.8% year over year to $636 million. The growth was driven by robust demand in current aerospace platforms fueled by impressive commercial sales (up 6%) and regional jet sales (up 15%). However, lower shipments in the military markets (down 12%) due to unfavorable customer demand and lower IGT sales led by poor aftermarket sales hurt the overall performance of this segment.
Forged Products sales declined 15.8% year over year to $905 million owing to negative impact from metal prices and contractual “pass-through” pricing issues. Lower military power sales (down 50%) due to challenges in the oil and gas market, coupled with sluggish industrial demand, were mainly responsible for this decline. Moreover, lower sales in the military market (down 15%) worsened the fall. However, higher sales in the commercial aerospace (up 4%) and regional/business jet markets compensated this fall to some extent.
Airframe Products sales fell 8.6% year over year to $746 million. The decline was largely brought about by lower sales in the aerospace and general industrial business lines. Inventory management efforts by key fastener customers adversely affected the performance of commercial aerospace sales. Also, lower sales in the military and regional/business jet markets acted as a significant headwind.
Outlook
Per a research conducted by The Airline Monitoras in Jun 2015, Boeing and Airbus aircraft deliveries are expected to witness moderate growth rate through the calendar year 2015. Encouragingly, Precision Castparts’production volumes are approximately three to six months ahead of aircraft deliveries for mature programs,mainly attributable to manufacturing lead times and scheduled build rates. Moreover, Airline Monitor further suggests that aircraft deliverables will continue to witness steady growth momentum throughout fiscal 2016.
In terms of end markets, the company believes commercial aerospace market will witness impressive growth primarily driven by higher build rates of the Boeing 787 and Airbus A350. Moreover, Precision Castparts believes strong potential of next-generation engines like LEAP engine will act as a key catalyst of growth for the commercial aerospace market. Higher production rates of F-35 are expected to drive growth of military aerospace market. However, government budget cuts and sluggish global GDP growth rates may act as a potential headwind for the military aerospace market.
Issues related to corporate profitability and commercial airline traffic indicators can affect sales of regional/business either in a positive or negative manner. While sales of large cabin business jets are expected to grow strongly, that of mid and small cabin business jets can be impacted adversely. Additionally, introduction of new generation turbines are expected to propel IGT demand positively.
Lower oil and gas prices are expected to act as potential headwinds for Oil & gas and other non-IGT power generation markets leading to lower exploration and production activities. Lower oil prices are also causing softness in “second-derivative”, which in turn, may impact general industrial and other markets adversely.
Margins
In 2Q fiscal 2016, the company’s consolidated operating income declined22% year over year to $548million,while operating margin fell 400 basis points (bps) to settle at 24%.