Woodward: A Unique Opportunity At A Crucial Time

Summary

• Woodward, Inc. recently scrapped its all-stock merger with Hexcel Corporation amid the coronavirus crisis.
• The companies no longer believed the deal made sense given the crisis in the airline industry.
• Woodward, Inc. also recently requested to reinstate its former CFO, Bob Weber Jr., due to the economic effects of the virus outbreak.
• The company recently furloughed 11% of its staff and is taking additional measures to preserve financial strength during this period of uncertainty.
• This article focuses on the fundamentals and what the real value is versus the current share price.
• Looking for more stock ideas like this one? Get them exclusively at Good Stocks@Bargain Prices. Get started today »

Woodward, Inc. (NASDAQ:WWD) recently announced its plan to end the merger with Hexcel Corporation amid the current coronavirus pandemic. The all-stock merger, which was agreed upon in January, would have combined the complimentary companies scale. However, both believe that successful integration would not be possible during the crisis. Once merged, the company “would have been one of the world’s biggest aerospace and defense suppliers” with significant free cash flow.

The company recently announced many changes related to the COVID-19 global pandemic. It furloughed 11% of its entire staff, with plans to further reduce the workforce an additional 4% throughout 2020. The company requested to reinstate former CFO Bob Weber Jr. to assist with the financial implications and economic impacts of the crisis. Additionally, Woodward, Inc. plans to preserve financial strength by enacting workplace management through hiring freezes, reducing company officers’ salaries and directors’ base retainers, implementing a company-wide wage freeze, eliminating 2020 bonuses, and reducing all non-essential costs.

While current news stories, good or bad can sway our opinion about investing in a company, it's good to analyze the fundamentals of the company and to see where it's been in the past and in which direction it's heading.

This article will focus on the long-term fundamentals of the company, which tend to give us a better picture of the company as a viable investment. I also analyze the value of the company versus the price and help you to determine if WWD is currently trading at a bargain price. I provide various situations which help estimate the company's value. In closing I will tell you my personal opinion about whether I'm interested in taking a position in this company and why.

Snapshot of the Company

A fast way for me to get an overall understanding of the condition of the business is to use the BTMA Stock Analyzer’s company rating score. It shows a score of around 72/100. Therefore, Woodward is considered to be a good company to invest in, since 70 is the lowest good company score. WWD has high scores for 10 Year Price Per Share, Earnings per share, Ability to Recover from a Market Crash or Downturn, and Gross Margin Percent. It has a mediocre score for ROE. It has low scores for ROIC, and PEG Ratio. A low PEG Ratio score indicates that the company may not be experiencing high growth consistently over the past 5 years. In summary, these findings show us that WWD seems to have above average fundamentals since the majority of categories produce average to above average scores.

Before jumping to conclusions, we’ll have to look closer into individual categories to see what’s going on.

(Source: BTMA Stock Analyzer )

Fundamentals

Let’s examine the price per share history first. In the chart below, we can see that price per share has been mostly consistent at increasing over the last 10 years, with the exception of the past year where share price has declined. Overall, share price average has grown by about 180.3% over the past 10 years or a Compound Annual Growth Rate of 12.13%. I would consider this to be an acceptable return.

(Source: BTMA Stock Analyzer – Price Per Share History)

Earnings

Looking closer at earnings history, we see that earnings have grown consistently over the past 10 years. The earnings grew gradually within the past decade besides a drop in 2018.

Consistent earnings make it easier to accurately estimate the future growth and value of the company. In this regard, WWD is a good candidate of a stock to accurately estimate future growth or current value.

(Source: BTMA Stock Analyzer – EPS History)

Since earnings and price per share don’t always give the whole picture, it’s good to look at other factors like the gross margins, return on equity, and return on invested capital.

Return on Equity

The return on equity has been mostly stable within the range of 15% to 16%, except for a dip in 2018.Five-year average ROE is around 15%. For return on equity (ROE), I look for a 5-year average of 16% or more. So WWD is slightly less than my requirement.

(Source: BTMA Stock Analyzer – ROE History)

Let’s compare the ROE of this company to its industry. The average ROE of 77 Aerospace/Defense companies is 31.42%.

Therefore, Woodward’s 5-year average of 15% and current ROE of 15.9% are well below average.

Return on Invested Capital

The return on invested capital has been low and inconsistent.Five-year average ROIC is poor at around 10%. For return on invested capital (ROIC), I also look for a 5-year average of 16% or more. So WWD does not pass this test either.

(Source: BTMA Stock Analyzer – Return on Invested Capital History)

Gross Margin Percent

The gross margin percent (GMP) has been lower than I’d like and declining over the past five years.Five-year GMP is around 26%. I typically look for companies with gross margin percent consistently above 30%. So WWD has not proven that it has the ability to maintain acceptable margins over a long period.

(Source: BTMA Stock Analyzer – Gross Margin Percent History)

Looking at other fundamentals involving the balance sheet, we can see that the debt-to-equity is less than 1. This is a good indicator, telling us that the company owns more than it owes.

WWD’s Current Ratio of 1.68 is good, indicating that it has a good ability to use its assets to pay its short-term debt. Ideally, we’d want to see a Current Ratio of more than 1, so WWD exceeds this amount.

According to the balance sheet, the company seems to be in good financial health. In the long term, the company seems fine in regards to its debt-to-equity. In the short-term the company’s financial situation is solid.

The Price-Earnings Ratio of 12.8 indicates that WWD might be selling at a low price when comparing WWD’s PE Ratio to a long-term market average PE Ratio of 15. The 10-year and 5-year average PE Ratio of WWD has typically been between 22.05 and 22.77, so this indicates that WWD could be currently trading at a low price when comparing to WWD’s average historical PE Ratio range.

WWD currently pays a dividend of 0.62% (or 1.41% over the last 12 months).

(Source: BTMA Stock Analyzer – Misc. Fundamentals)

The Story Behind The Dividend

In regards to dividend history, I’m first interested in knowing if the payout ratio is sustainable. At this time, it’s around 16%, which means that there is still a ton of room to grow the dividend. Also notice that WWD has a regular history of buying back shares, which contributes to higher payout ratios.

If we look only at the dividend yield, we see a range of 0.55% to 1.31%. This stock pays out a small dividend. Dividend yields haven't increased consistently over the 5 year period, therefore this stock may not be desireable for dividend investors.

Although WWD participates in share buybacks, sometimes buybacks don’t make sense, as according to Warren Buffett: “There is only one combination of facts that makes it advisable for a company to repurchase its shares: First, the company has available funds -- cash plus sensible borrowing capacity -- beyond the near-term needs of the business and, second, finds its stock selling in the market below its intrinsic value, conservatively calculated.”

In the example of WWD, the company appears to have ample equity as indicated by its satisfactory debt-to-equity ratio and its short-term financial situation seems solid as indicated by its current ratio. Now let’s consider its borrowing capacity.

With a debt to EBITDA ratio of 2.0, Woodward uses debt artfully but responsibly. Woodward’s conversion of EBIT to free cash flow suggests it can handle its debt as easily. It does seem that Woodward has a sufficient borrowing capacity.

Now to see if the buyback timing made sense. From the view of a share price chart over the past 5 years, the best time to do share buybacks would have been when WWD was declining in stock price. This would have been around 2018. If we look at the dividend chart above, we can see that during 2018, was a time when WWD wasn’t buying back any shares, which gives me the impression that Woodward isn’t purposely planning share buybacks with a strategic plan to return the most value to shareholders.

If I were currently interested in buying WWD now for the dividend, I would be trying to buy when the dividend yield was highest relative to its past. From the chart below, we can see that the dividend yield is at a high point relative to the past 10 years. Therefore, it’s an ideal time to buy now if my priority is a better than average return through dividends.

Overall, the dividend situation with WWD is ho-hum. On the positive side, the dividend yield is at a high level when compared with the past 10 years.

On the negative side, the stock pays a small dividend that has not been consistently increasing dividend yields over the past 5 years.

In addition, share buy backs haven’t been completed at an opportune time to return the most value to shareholders.

This analysis wouldn’t be complete without considering the value of the company vs. share price.

Value Vs. Price

For valuation purposes, I will be using a diluted EPS of 4.02. I’ve used various past averages of growth rates and PE Ratios to calculate different scenarios of valuation ranges from low to average values. The valuations compare growth rates of EPS, Book Value, and Total Equity.

In the table below, you can see the different scenarios, and in the chart, you will see vertical valuation lines that correspond to the table valuation ranges. The dots on the lines represent the current stock price. If the dot is towards the bottom of the valuation range, this would indicate that the stock is undervalued. If the dot is near the top of the valuation line, this would show an overvalued stock.

(Source: BTMA Wealth Builders Club)

According to this valuation analysis, WWD is undervalued.

• If WWD continues with a growth average similar to its past 10 years earnings growth, then the stock is undervalued at this time.

• If WWD continues with a growth average similar to its past 5 years earnings growth, then the stock is undervalued at this time.
• If WWD continues with a growth average similar to its past 10 years book value growth, then the stock is undervalued at this time.
• If WWD continues with a growth average similar to its past 5 years book value growth, then the stock is undervalued at this time.
• If WWD continues with a growth average similar to its past 5 years total equity growth, then the stock is undervalued at this time.
• According to WWD’s typical PE ratio relation to the S&P 500's PE Ratio, WWD is undervalued.
• If WWD continues with a growth average as forecasted by analysts, then the stock is overpriced.

This analysis shows an average valuation of around $77 per share versus its current price of about $59, this would indicate that Woodward, Inc. is undervalued.

It is clear that in the past, WWD has typically sold at a premium when considering WWD’s PE Ratio compared to the S&P 500 PE Ratio. In addition, all analysis considering the past growth of WWD would indicate that Woodward is currently undervalued. But when we consider the current Coronavirus pandemic and how it has affected the economics of the airline industry, future estimates of Woodward’s growth are much weaker and unpredictable. For those reasons, when valuing this company,I would err on the more conservative valuation based on Low Forward Growth. This valuation estimates that WWD could be worth closer to $36 to $38.

Forward-Looking Conclusion

According to the facts, Woodward Inc. is financially healthy in a long-term sense in having enough equity as compared with debt, and in the short-term because the current ratio indicates that it has enough cash to cover current liabilities.

Historical earnings have been solid and consistently increasing.

Other fundamentals include a decent ROE, lacking ROIC, and worrisome Gross Margin Percent that has been at low levels and decreasing over the past five years.

The dividend situation is not great since the company’s dividend yield is small and hasn’t been increasing consistently over the past five years.

Lastly, this analysis shows that the stock is undervalued, but when considering the negative affects that the pandemic has inflicted upon the airline related industries, I’m erring on a more conservative view that the stock could fall more.

It can be revealing to compare the past performance of WWD vs. the benchmark S&P 500 as seen in the chart below. Notice that WWD typically outperforms the S&P 500 during booming times, but when there’s an economic downturn WWD can fall drastically. During the economic crisis of 2008/2009 and the current pandemic crisis, this dramatic decline is obvious. This tells me that this stock offers a unique opportunity to buy during a major economic downturn and to capitalize on gains when selling during an economic boom period.

For me, the choice is certain. I would take an objective look at this company and realize that I’m not in love with Woodward Inc. The fundamentals are better than average and the dividend situation could use much improvement. Financially, the company is stable. During most normal years, I could expect a long-term return of around 8-12%. It’s nothing spectacular, but it’s acceptable.

But here’s the kicker with Woodward. It’s in a unique industry at a unique time. Yes, the airline industry has been hit hard by the Coronavirus pandemic and it will likely suffer more damage or volatility in share price as future earnings are reported. On the flip side, Woodward has some diversification and doesn’t rely solely on the commercial airline industry. It makes components for trains, diesel applications, industrial products, products for the energy industry, and products for the government/defense industry (approximately 23% of sales).

That being said, Woodward will likely survive this pandemic and when things return closer to “normal”, the stock will probably be selling at a premium eventually.

Plus, the US government has repeatedly shown and expressed that it is open to bailing out the airline industries and airline manufacturers like Boeing (BA). So, this shows some support for Woodward’s share of revenue that comes from the commercial airline division as well.

With these considerations, I’d be willing to buy Woodward if the stock should fall to a ridiculously low price with the intention of selling when the economy and airline industry recovers and to sell Woodward at a nice profit. Since I like other good companies better than Woodward right now, I would invest a smaller amount of capital into this company. But for me the benefit to risk ratio is in my favor if I can buy Woodward at a greatly reduced price during this unique opportunistic time.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in WWD over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.