Fly High With This Aerospace Company

Madhukar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The Department of Defense, or DOD, spent $655 billion on defense activities last year, which is expected to drop by $28.2 billion in the current year. A plunge in the defense budget was due to austerity measures. Going forward, the DOD is expecting to spend $621.6 billion in the next year.

Downsizing the defense budget can cause adverse effects on the revenue of aircraft manufacturers, as the DOD is one of the largest buyers of defense aircrafts, helicopters, and other equipment. I am analyzing Esterline Technologies (NYSE: ESL), which supplies parts and equipment to aircraft manufacturers. Let's find out whether spending cuts by the DOD will affect the performance of original equipment manufacturers. 

Esterline is a leading player in the aerospace and defense industry, supplying unique parts to companies like Boeing (NYSE: BA), Airbus, and Lockheed Martin (NYSE: LMT). The company operates in three product segments:

i. Advanced materials

ii. Sensors and systems

iii. Avionics and controls

In the latest second-quarter results, the company posted revenue of $499 million, up 9% quarter-over-quarter. The company has pocketed promising projects in the past and is associated with future projects as well. Esterline grew its revenue at a CAGR of 17.8% in the last 10 years, and it increased its free cash flow from $16 million in 2002 to $145 million in the last year. The company's unique products helped foster its growth in the past years. Esterline has maintained its growth momentum by weighting equally in commercial aerospace and defense projects.

Metric

% of total revenue

Commercial aerospace

40%

Defense

40%

Adjacent applications

20%

Demand for Lockheed aircrafts

Esterline recently received a contract to supply sealing and low observable products used in the production of Lockheed's F-35 Lightning II. This aircraft belongs to the F-35 family, and is used by the U.S. Air Force, Navy, and Marine corps. Pentagon plans to buy 1,200 planes from the F-35 family in the next few years.

It will spend around $7.2 billion on F-35 Lightning II planes this year, expecting delivery of 29 units by Lockheed. Moreover, it may spend above $8 billion in the next year. Esterline generates $900,000 per ship by supplying its products to Lockheed. This can result in a revenue opportunity of around $26 million from this aircraft this year.

Commercial aerospace

Esterline's performance largely depends upon aircraft manufacturing companies, as it is an OEM. The company is a global market leader in manufacturing and designing analogue indicator parts it supplies to aircrafts like Tornado, Hawk, and Airbus A380. There is a strong 105 aircraft order backlog of Airbus A380, which will benefit Esterline. Moreover, at the Paris Air Show, Doric gave order to purchase 20 new A380 planes from Airbus. As a result of recent orders, total Airbus A380 backlog increased to 125. Esterline charges $1 million per ship to Airbus for supplying analogue indicator parts. Thus, its revenue should receive a boost due to the increasing Airbus order backlog.

Going forward with the commercial aerospace discussion, Esterline designs and manufactures cockpit overhead panels and entrenched software for the Boeing 787. It also received a contract from Boeing to supply sensors for the environmental control system, or ECS. The ECS controls air supply, thermal control, and cabin pressurization in aircrafts. For delivering these parts, Esterline charges $600,000 per ship for the Boeing 787.

A few months ago, regulators around the world raised questions concerning the Lithium batteries used in Boeing 787, affecting the image of the Boeing 787. Since the company resolved this technical problem of the Lithium battery, Boeing added 83 new 787 planes to its order book this year. With the increasing order backlog, Esterline's profit should improve going forward.

Benefits from rivalry

Airbus specifically designed A400M aircraft to cater to the needs of different air forces across the globe as it has a high-speed turboprop engine. The usage of A400M became more critical as it will replace the aging C-130 Hercules and C-160 Transall. Airbus received approval for this aircraft in May 2013, and it will deliver the first A400M to the French Air Force in the second half of this year. The A400M order book is showing 174 deliveries scheduled, and therefore, it has captured global market share of 32% in the heavy lift aircraft market.

Industry analysts estimate that the company will push the production to 2.5 aircrafts per month by 2015, and it will take around six years to deliver 174 aircrafts. Esterline is designing and managing the supply of sensor suite for the turboprop in the A400M, which is good news for investors. The company generates revenue of $1.2 million per aircraft, and should generate around $210 million by supplying sensor suite for the A400M in the upcoming six years.

On the other hand, Esterline generates significant revenue from Boeing as well, as it supplies products for the Boeing P-8. Esterline generates revenue of $1 million per aircraft from the Boeing P-8 aircrafts. P-8 is the advanced anti-submarine and anti-surface warfare aircraft, providing long range maritime scouting. There is a series of other aircrafts in the P-8 product line, such as P-8A Poseidon, P-8I, and P8 AGS. Last year, the U.S. Navy ordered 11 additional P-8A Poseidon for around $1.8 billion, amounting to 24 aircraft in total. In the current year, the company ramped up the production of P-8A aircraft, and it expected to deliver 11 aircrafts, including three to the Indian Navy.

Conclusion

Source: Yahoo!

Going forward, the company's deals with Boeing, Airbus, Lockheed, and Beechcraft should result in surging revenue and help maintain shareholders' confidence, too.

Moreover, Esterline's forward P/E is 13.81, and its current P/E is 24.58. Lower forward PE is the sign of rising earnings of a company in the next year. In addition, due to the greater opportunity in defense and commercial aerospace, I assume the company’s stock price appreciate in the upcoming years.

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Madhukar Dubey has no position in any stocks mentioned. The Motley Fool owns shares of Lockheed Martin. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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