Not Enough Margin of Safety in Precision Castparts

Dec.28.08 | About: Precision Castparts (PCP)

Precision Castparts (NYSE:PCP) has been hurt by the Boeing (NYSE:BA) strike but should benefit when the 787 moves into production later in 2009. Backlog continues to be strong, but performance may deteriorate as aerospace and power generation feel the effects of the weak economy. As a result, it is extremely difficult to judge how earnings may evolve over the next couple of years.

BUSINESS OVERVIEW

Precision Castparts operates in three segments:

Investment Cast Products manufactures investment castings for aircraft engines, IGT engines, airframes, armaments, medical prostheses, and other industrial applications.

Forged Products consists of the forging operations of Wyman-Gordon and the nickel-based alloys and superalloy production of SMC, acquired in Q1 FY07.

Fastener Products produces fasteners, fastener systems and components for critical applications in the aerospace, automotive and industrial machinery markets.

SELECTED OPERATING DATA

FYE March 31

2006
2007
2008
1H09

% of revenue by segment:

Investment cast products

45%
33%
32%
33%

Forged products

26%
44%
46%
44%

Fastener products

29%
23%
22%
23%

Revenue growth by segment:

Investment cast products

na
11%
24%
16%

Forged products

na
163%
35%
1%

Fastener products

na
20%
25%
14%
D revenue
22%
53%
29%
8%
D backlog (period end)
32%
54%
26%

EBIT margin by segment:

Investment cast products

20%
22%
24%
25%

Forged products

13%
17%
22%
21%

Fastener products

17%
21%
25%
28%
Corporate
-1%
-2%
-1%
-1%
Total EBIT margin
16%
18%
22%
23%

D&A as % of revenue

2.7%
2.1%
1.9%
2.0%

Capex as % of revenue

2.7%
4.1%
3.3%
2.9%

% of revenue by market area:

Aerospace
59%
53%
55%
n/a

Power generation

18%
21%
24%
n/a

Industrial and automotive

23%
26%
21%
n/a

% of revenue by geography:

U.S.
85%
80%
80%
n/a
U.K.
10%
14%
13%
n/a
Other
4%
6%
7%
n/a

% of revenue by 10%+ customer:

GE1
17%
12%
12%
n/a
Click to enlarge

1Other key customers include United Technologies (NYSE:UTX) and Rolls Royce (OTCPK:RYCEY).

INVESTMENT HIGHLIGHTS

  • Cast products performing well, driven by “robust” aerospace demand, OEM and aftermarket shipments and industrial gas turbine (IGT) growth. Product lines are well-positioned on aerospace production programs; IGT volume is near all-time highs. There is “continued [margin] upside going forward.”
  • Forged products stagnating, reflecting steady aerospace component demand, strong seamless pipe sales and lower selling prices of external alloy sales. Sales of nickel alloy mill forms are improving.
  • Fastener products growing in mid teens, driven by strong sales of critical aerospace fasteners, partially offset by lower automotive fastener sales.
  • Contractual pass-through of raw material price increases helps offset rising costs. The company has escalation clauses for nickel and other metals in “certain long-term contracts,” and employs price-in-effect metal pricing to lock-in alloy production cost.
  • Acquisitions have contributed to growth, and the company continues to pursue deals.
  • Chairman and CEO Mark Donegan (51) has been with the company for more than 15 years.
  • Stock price implies 7x trailing P/E and 6x forward P/E.

INVESTMENT RISKS & CONCERNS

  • Four-fifths of revenue from cyclical aerospace and power generation markets. Commercial aerospace depends on new aircraft demand. Military aerospace depends on government funding. Power generation demand depends on economic strength.
  • Hurt by Boeing strike, with orders pushed out.
  • Dependent on Boeing 787 and Airbus A380 programs as major component supplier. The 787 is expected to move into production later in 2009.
  • Management turnover, including departure of forged products president Ayers in July and the retirement of CFO Larsson at the end of CY08.
  • Competitors include Alcoa (NYSE:AA) and Ladish (NASDAQ:LDSH) in cast products. Forged product comps include Ladish, Fortech and Thyssen in aerospace turbines; Alcoa and Schultz in structural products; Vallourec/ Mannesmann and Sumitomo in energy; and Allegheny (NYSE:ATI), Carpenter (NYSE:CRS) and Haynes (NASDAQ:HAYN) in nickel alloys. Fastener comps include Alcoa, LISI, McKechnie.

COMPARABLE PUBLIC COMPANY ANALYSIS

($mn)
MV
EV
EV/Rev
P/TB
08 P/E
09 P/E
AA
8,675
18,028
.6x
0.9x
7x
11x
ATI
2,041
2,285
.4x
0.9x
4x
5x
CRS
704
632
.2x
1.0x
5x
4x
LDSH
241
351
.8x
1.2x
7x
6x
PCP
7,674
7,585
1.1x
3.8x
7x
6x
Click to enlarge

MAJOR HOLDERS

CEO Donegan <1% │ Other insiders 1% │ Cap Re 8% │ Lone Pine 2%

RATINGS

VALUE

Intrinsic value materially higher than market value?

***
MANAGEMENT

Capable and properly incentivized?

***
FINANCIAL STRENGTH

Solid balance sheet?

****
MOAT

Able to sustain high returns on invested capital?

***
EARNINGS MOMENTUM

Fundamentals improving?

***
MACRO

Poised to benefit from economic and secular trends?

**
EXPLOSIVENESS

5%+ probability of 5x upside in one year?

**
Click to enlarge

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