Secular Themes - Investing in Business Jets
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Business jet usage and growth is one of my preferred long-term investing trends and recent results from industry leaders Textron (NYSE: TXT) and General Dynamics (NYSE: GD) highlight the bullish thesis. I first highlighted Textron back in December 2011 with the stock price at $18. It now resides at $25 following two consecutive blow-out earnings releases. The bullish outlook essentially rests on the concept that the increasing number of ultra-wealthy individuals will seek to maximize their one limited resource-TIME. They do this via ownership of business and general aviation aircraft. Not only do the stocks offer great growth potential, but they possess other favorable characteristics that set the stage for notable outperformance.
Textron reported 2Q12 EPS of $0.58, a 14c beat that sent the stock soaring more than 11% on the day. Earnings-per-share expanded 100% compared to 2Q11 with revenues up 10%. That is some serious operating leverage and highlights the strong EPS growth potential. Textron is a diversified conglomerate comprised of business jets, helicopters, military, and industrial segments. Annual sales exceed $11 billion and the company has a market capitalization above $7 billion. The Bell Helicopter division and military segments bring an element of stability along with modest, steady growth whereas the Industrial segment produces GDP-type growth. The topic of discussion here is the growth potential in the Cessna jet unit, which comprises about 25% of sales with an earnings impact that can approach 50% of total profit during boom times.
Cessna Citation unit deliveries in the 2Q were 49 compared to 38 in 2Q11 with a notable uptake in segment operating profit. The Cessna unit is highly leveraged with high fixed costs, a determent in down times and a goldmine in the subsequent cyclical expansions. Segment operating revenues are 75% new sales and 25% after-market, again a bit more highly leveraged to new sales. Many industrial peers garner a 50/50 split between product sales and after-market service. The division also has favorable geographic attributes with the U.S. accounting for 70% of sales and Europe just 11%. It can withstand a European slow-motion train wreck. The company has huge earnings growth potential to just return to 2008 peak sales. The company delivered 467 business jets and many more single-engine units in 2008. The bottom fell out of the market during the Global Financial Crisis with annual business jet deliveries falling to less than 200. The company ended 2011 with 183 deliveries. This inherent growth potential is why earnings-per-share expanded 60% in 2011 and is forecast to grow another 50% in 2012 before resuming a 15-25% medium-term growth profile.
For this growth profile, the stock trades at a very reasonable 19x trailing earnings-per-share and just 13x forward earnings-per-share. The trailing-twelve-month free cash flow yield is attractive at 8%. The stock offers exceptional long-term secular growth potential at an attractive valuation today.
The Safer Alternative
General Dynamics, the owner of the Gulfstream brand, demonstrated strength in its aviation unit as well. The company reported 2Q12 Gulfstream sales advanced 16% versus a year earlier and management is forecasting 15% growth for the remainder of the year. General Dynamics is much less levered to business jets than Textron and is more appropriate for investors with a lower risk tolerance profile. Along with its business jet unit, the company is a key military contractor and operates in segments such as tanks, munitions, submarines, and military communications. They get about 70% of revenues from the Department of Defense and have less than 10% exposure to Europe. The defense segment will see minimal growth in coming years, but will yield steady cash flow that should continue to support the stock.
Despite the strong quarter in aviation sales, the company did note some weakness in its communication division and reduced full-year guidance that essentially implies flattish earnings-per-share growth relative to 2011. The book-to-bill for the aviation unit was weak as well, but this hinges on the fact that the new G650 has yet to attain certification. This should happen in the third quarter and be a catalyst for the stock, which is down 5% year-to-date.
The valuation on this stock is compelling with a FCF yield of 12% and a price-to-earnings ratio of 8x, both significantly cheaper than the market average. The stock has great dividend attributes and makes a good addition to anyone’s portfolio on these merits alone. The dividend yield is an above-average 3.2%, the payout ratio a modest 26%, and the five-year average growth rate is a strong 13%.
The buy thesis on this stock rests on the concept of a cheap valuation and significant upside in the Gulfstream brand. This is a cheap stock with below market volatility. I think the stock should continue growing dividends at a double-digit rate, a favorable position to be in while waiting for the business jet outlook to fully materialize.
Business jets have strong secular appeal as the rising ultra-wealthy seek to maximize their time. This creates huge opportunities for Textron and its Cessna division. Investors can still jump aboard and catch most of the upside, but they need to be mindful of timing. I favor the long-term outlook, but am cautious near-term as a global recession takes hold. This highly volatile stock may still do a touch-and-go landing before soaring. Gulfstream is the much more conservative choice and should appeal to accounts that favor dividend growth, but also want the potential for market outperformance. Gulfstream has much less downside risk and serves as a great substitute for low-yield bond funds.
market8 has no positions in the stocks mentioned above. The Motley Fool owns shares of General Dynamics and Textron. 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.If you have questions about this post or the Fool’s blog network, click here for information.