A Highly Anticipated Move Linked with Industry Leading Dynamics

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'With few exceptions, every aircraft in the sky flies with parts made by Precision Castparts'

The statement above by Precision Castparts (NYSE: PCP) clearly shows its supremacy in the industry. PCP is a leading manufacturer of high quality components serving the aerospace, power, and industrial markets. The company enjoys a monopoly in producing large metal castings, meeting cost and quality standards for its customers.

The recent 13F disclosures by the holding companies with shares of PCP support the fact that this stock is a favorite among investors looking for high returns. This makes me all the more interested in this global pioneer.

Take a look at some of the funds that own PCC:

<table> <tbody> <tr> <td> <p><strong>Fund Managers</strong></p> </td> <td> <p><strong>No of shares</strong></p> </td> </tr> <tr> <td> <p>Vanguard</p> </td> <td> <p>6.24 million</p> </td> </tr> <tr> <td> <p>State Street Corporation</p> </td> <td> <p>5.34 million</p> </td> </tr> <tr> <td> <p>Alliance Bernstein</p> </td> <td> <p>2.27 million</p> </td> </tr> <tr> <td> <p>Berkshire Hathaway</p> </td> <td> <p>1.25 million</p> </td> </tr> <tr> <td> <p>Franklin Resources</p> </td> <td> <p>1.16 million</p> </td> </tr> </tbody> </table>

The company's acquisition plans & its competitive edge are discussed in detail below:

A Strategic Acquisition

In the last year and a half, the company has successfully closed 13 deals to extend its product offerings, which have played a major role in its growth and also in its cost control strategy, leading to its strong market presence. On this front, one significant aspect to look forward for the company is its recent acquisition of Titanium Metals Corporation (UNKNOWN: TIE.DL) at $16.50 per share for a total of $2.9 billion.

TIMET is the leading producer of titanium in the US and has been a major supplier of PCP, supplying ~80% of the Titanium used by the company over decades. The acquisition will be an important tool for PCP to reduce costs and improve efficiency via vertical integration. It will also help PCP to further enhance its titanium capacities. Looking at PCP's acquisition history, this is the biggest deal for the company and I believe this will help it to reduce cyclicality of the company's business, generally prevailing in the industry, similar to its highly successful acquisition of the nickel-producer SMC in 2006.

As for the financial perspective, I expect the acquisition to add ~$0.45 to its EPS on an annualized basis. The transaction is expected to close by the end of this year, and looking at the huge demand for titanium (100 million pounds by the end of the decade), I see this deal generating huge cost and revenue synergies for the company. As the CEO Mark Donegan rightly called the deal “a needle mover” and said it to be a “key missing piece” of the company's product portfolio.

Threat to Competitors

Looking at its competitive position, this deal would be a potential threat to PCP's competitors, such as Allegheny Technologies Inc. (NYSE: ATI), RTI International Metals, Inc. (NYSE: RTI), Carpenter Technology Corp (NYSE: CRS). After this deal, PCP would be able to match up with the Allegheny position in Titanium melting and Titanium sponge production. In the longer run, the cost cutting opportunities for PCP and the PCP/TIMET deal pose a risk to Allegheny’s position in the forging space.

Another Titanium manufacturer in the industry (RTI International Metals) is the direct competitor of Titanium Metals Corp. However, TIMET is a lower cost producer of Titanium than RTI international, and this would be another favorable point for the company after the PCP and TIMET combination. Also, to compete against RTI in the aero structural space, PCP has been acquiring major structural producers such as Primus, Klune, etc.

Talking about the financial aspects of the company, its cash flow generation capacity has always remained attractive. Its sharp focus on cost reduction has enabled PCP to achieve a ~90% free cash flow conversion rate. I expect PCP to continue with its strong cash flow of ~$1.3 billion in 2013 and ~$1.5 billion in 2014, which it would be able to use to leverage its capabilities in acquisitions to support its top line growth.

Looking at the company's stable position in the aerospace market and the favorable energy market, which accounted for ~60% and ~20% of its sales in 2012, respectively, and the big names in its customers base such as General Electric, Boeing, Airbus, Rolls-Royce, etc. makes me feel positive about its future revenue generation ability. The recently announced increased production rates by Boeing and Airbus, such as 787 and A350, will boost up the company's sales & profits in near term. Also, the excellent execution by the management team, a well proven and successful cost structure, and the enhancement via acquisitions makes PCP a must own stock.


ShwetaDubey has no positions in the stocks mentioned above. The Motley Fool owns shares of Titanium Metals. Motley Fool newsletter services recommend Precision Castparts and Titanium Metals. 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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