Textron (TXT) is strengthening its major business units, shedding nonessential operations, and is poised to capitalize on a global economic recovery as well as emerging market growth.
Cessna Aviation: After taking a very hard hit during the recession, Textron's Cessna unit returned to profitability in 2011. Textron has ramped up R&D spend recently to be able to bring new aircraft to market as private aviation sales rebound as well as be able to focus on emerging market private aircraft growth. Upcoming new Cessna models include the Corvallis TTx turboprop (2012), Citation TEN (late 2012), Citation M2 (2013), and Citation Latitude (2015). Private aircraft sales have declined for 4 straight years but are expected to rebound in 2012. Honeywell (HON) is projecting 3-5% growth in private aircraft sales compared to 2011 which would equate to roughly 700 new airframes.
There is currently a big push into China for these private aircraft manufacturers as they see tremendous growth opportunities there. Companies targeting China include Berkshire Hathaway's (BRK.A) NetJets and Embraer (ERJ). To capitalize on China's expected growth, Textron formed a JV with Aviation Industry Corporation of China (AVIC) and plans to co-develop several aircraft.
Bringing new models to market at a time when the amount of new planes expected by competitors is sparse should strongly benefit Cessna. It is difficult to ascertain the potential benefit of the recent bankruptcy of one of Cessna's competitors, Hawker, but Textron management has stated that it will be exploring any options to acquire assets from Hawker at a steep discount.
Bell Helicopter: Bell Helicopter is by far the most profitable segment with a profit margin of 14.8% in 2011 and guidance for a margin between 13-14% in 2012. The strongest aspect of Bell's product portfolio is the V-22 Osprey, a revolutionary tilt-rotor aircraft developed for the US military under a JV with Boeing. Other military models include the H1 attack helicopter and the 407 AH. Military sales account for over 60% of total Bell sales. Bell has a contract to supply the US military with V-22s through 2014 and upside potential comes from the opening of the program to US allies such as the UK, Israel, the UAE, and Canada.
Commercial sales doubled for Bell in 2011 from 2010 and they are further improving their position in the commercial market with the new 407GX expected in 2012 and the 525 Relentless, which was well received when it debuted at the 2012 Dallas Heli-Expo. Bell is pioneering a new "Super-Medium" category with the 525 Relentless that is best described as large helicopter capabilities on medium helicopter economies.
Textron Systems: Textron Systems markets unmanned aircraft systems, land & marine systems, mission support technologies, and weapons & sensors to the US military. Given the uncertainty of the US Defense budget over the next few years it's unlikely to see tremendous upside for this segment but it should remain stable due to the nature of its business building smaller ticket items that are less likely to be cut than larger programs such as Lockheed's F-35 program. Recent highlights for Textron Systems include the $500 million production contract for the company's Armored Security Vehicles (ASV) recently awarded by the US military and the successful testing of the Common Unmanned Surface Vessel, a drone vessel that could be production-ready in less than 1 year and will be marketed to the US Navy and the navies of US allies.
Industrial Segment: The industrial segment encompasses the brands of Kautex fuel systems, E-Z-GO golf equipment, and Greenlee turf care. Upside in this segment will be largely generated by a pick up in global auto sales.
Textron Financial: Textron's plan to liquidate the non-captive portion of its finance receivables portfolio that was put in effect in Q4 2008 is going very well. In 2011, the company was able to remove $1.7b of non-captive receivables off its books leaving $950m remaining. Textron's liquidation expectations for 2012 were $350m and just reported liquidations of $171m for the first quarter so they are almost halfway towards their target with plenty of time remaining. The liquidation of the non-captive finance receivables allows the company to free up capital and focus on the captive portion of its financing operations that is used to facilitate financing for Bell and Cessna aircraft thus contributing to the upside potential for those two business units.
Financials and Valuation
Balance Sheet: Textron's balance sheet appears to be fairly healthy. The company has steadily decreased its long-term debt obligations from $9.1b in 2009 to $4.5b where they stand as of 3/31/12. 55% of debt is attributable to the finance segment and 45% is attributable to the manufacturing segments. The current portion of long-term debt to be retired within the next 12 months equates to $464m. Debt/equity leverage decreased from Q4 2011 to Q1 2012 from 5.9x to 5.5x and management is committed to decreasing it further.
Valuation: Despite trading at a relatively high multiple compared to its peers at 23x TTM EPS, Textron is undervalued when the company's growth rate is factored in as evidenced by the low PEG ratio. In January the company guided for 2012 EPS of $1.90 and confirmed those EPS targets in their Q1 earnings call stating they expect earnings to be in the $1.80-$2.00 range which is in line with the street's estimates.
I'm placing an intermediate-term (9-12 month) price target on Textron stock of $31 per share based on a 16.5x multiple on $1.90 FY 2012 earnings and a 0.7x P/S ratio based on $12b in revenue (a discount relative to peers). With an earnings growth rate north of 20% expected from 2013 to 2016, a 16.5x earnings multiple is based on investors paying the same multiple comparable to growth as they are today.
Entry Target and Outlook
Textron is a great addition to a portfolio positioned to take advantage of a rebounding global economy and emerging market growth. Due to the strong cyclical nature of this company, shares should be held with caution as domestic recovery setbacks and adverse global economic data will strongly affect prices in a negative manner.
Aerospace/Defense is traditionally a very shareholder friendly sector and prior to the recession Textron paid out on average 45% of its earnings as dividends to shareholders. The current payout ratio is less than 10% but I expect this to increase as the company's earnings increase and the remainder of the non-captive financial receivables are liquidated. The yield on these potential dividends on investments made at these prices would be substantial.
The optimal price range to accumulate shares appears to be the low to mid $20s. I anticipate that the market will produce attractive entry points through the summer.