Since I first wrote my bullish article on Boeing (BA) here, the stock has soared by 17.7%, beating the S&P 500 by 720 basis points over the same time period. Despite the fact that the company is rated near a "strong buy" on the Street (see here), I now find that its value gap - in addition to that of Lockheed (LMT) - has been more or less closed. Textron (TXT), on the other hand, has strong upside.
From a multiples perspective, Lockheed is the cheapest of the three. It trades at a respective 10.5x and 9.7x past and forward earnings with the highest dividend yield at 4.7% and the least volatility (30% less than the broader market). Textron and Boeing, meanwhile, trade at a respective 11.4x and 13x forward earnings.
On the third quarter earnings call, Lockheed's CEO, Bob Stevens, noted how politically exposed the sector is:
"Domestically, the environment remains fluid, driven principally by the ongoing deliberations on potential reductions to federal budget levels. The recently enacted Budget Control Act of 2011 increased the federal government's borrowing limit, while reducing projected government spending over the next 10 years. It also established the bipartisan congressional joint select committee on deficit reduction, sometimes referred to as the super committee with a debt panel, which is charged with recommending legislation by November 23. The enactment of which would result in spending and revenue changes that would reduce net government spending by at least $1.2 trillion over the next 10 years.
If the super committee fails to recommend legislation or the Congress fails to approve that legislation by December 23, or the President fails to sign that legislation into law, then an automatic sequestration process would be triggered, which would make up any shortfall necessary to achieve the $1.2 trillion target. Under the budget act, 50% of any shortfall would automatically be applied as a reduction to the discretionary appropriations for national defense programs."
Now that the supper committee has failed, the hundreds of billions in defense cuts will begin in 2013. Boeing, which has a mammoth commercial aviation business, is perhaps best suited to navigate these "headwinds." Interestingly, the company has underperformed peers since the deadline past - an indication that the market has not factored in this value. With that said, projected earnings for the company, in my view, do not support meaningful appreciation.
Consensus estimates for Boeing's EPS forecast are that it will decline by 13.7% to $4.60 in 2012 and then by 24.1% and 15.2% more in the following two years. Of the 24 revisions to estimates, 22 have gone down for a net change of -7%. Assuming a multiple of 14x and a conservative 2013 EPS of $5.66, the rough intrinsic value of the stock is $79.24, implying 6.9% upside.
Textron, on the other hand, has positive momentum pointing toward value creation. 4Q EPS of $0.49 solidly beat consensus with improved performance in Industrial, Bell and Cessna. The last of these segments had a backlog decline of 35% y-o-y and saw profits of $60M. Bell has done well handling its cost base, resulting in margins being around 300 bps better than expectations at 15.4%. While V-22 has noticeable vulnerable to the defense cuts that will drive increased volatility, pension headwinds are appropriately being addressed to offset uncertainty. Management guided for 2012 sales of $12.5B, a 11% y-o-y return. Losses stemming from disposed assets are further falling and inspiring investor entry.
Consensus estimates for Textron's EPS forecast that it will grow by 39.7% to $1.83 in 2012 and then by 22.4% and 17% more in the following two years. Modeling a CAGR of 26% for EPS over the next three years and then discounting backwards by a WACC of 9% yields a fair value figure of $32.67, implying 28.5% upside.