2 Aerospace Firms Ready to Surge, 1 to Buy with Caution
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Although defense & aerospace are being compromised by expectations of lower government spending, there are still producers out there that are safe thanks to diversification. Others are more risky in light of high multiples and weak supply chains. Below, I review the fundamentals of two producers I strongly recommend and one producer I am mildly optimistic about.
Honeywell (NYSE: HON): Won't Underperform, But Not Incredibly Undervalued
While Honeywell may be a strong company led by top management, it is still fairly expensive at 23.1x past earnings. This is especially concerning given the 1.4% annual EPS decline over the last 5 years - a trend that won't be too easy to turn around, given projections for defense cuts. With a beta of 1.35, the stock is likely to generate either strong returns or devastating losses for shareholders.
There are several reasons why you may be tempted to hold out. One of them has to do with supply chain problems: Honeywell recently announced that it may take up to 12 months to upgrade its Metropolis Works uranium facility so that it can withstand Mother Nature. And while earnings has beaten analyst expectations in all of the last 5 quarters by an average of 4.4%, the future is still uncertain in light of talks over cutting government spending.
I am, however, optimistic about the company's decision to acquire 70% of Thomas Russell, which is engaged in providing equipment for natural gas processing. I believe that low natural gas prices will be exploited when economic activity picks up and that this purchasing decision will have been well timed. With only a debt to market cap of <7%, the company's financial position also won't be meaningfully compromised by the transaction. In fact, the transaction itself won't add much materially to the income statement. However, it signals management's interest in natural gas - a resource that has strong positive secular trends arising from foreign policy and environmental concerns.
Moreover, performance has been so strong that management has increased guidance for the year. Management is seeking to expand into new products and emerging markets, while remaining generous on the dividend distribution, which has plenty of liquidity on the balance sheet to support it. While I believe shares are expensive, I find the stock to be positioned more towards the upside than downside.
Boeing and United are both more attractive than Honeywell from a multiples perspective. In fact, Boeing trades at a respective 12.7x and 13.1x past and forward earnings versus corresponding figures of 13.2x and 12.5x for United. Analysts are optimistic about both stocks and rate them around a "strong buy."
In terms of annual EPS growth, analysts are projecting 11.5% for United, which is 100 bps greater than what is being projected for Boeing. Citigroup recently suggested that Boeing will likely implement a $2 billion buyback program and increase dividends by 20%. And despite all of the talk about defense cuts, Boeing has held its own with a five-year $2 billion contract with the US military. Despite these impressive fundamentals, the company is very cheap against its historical 5-year average PE multiple of 17.6x.
It should be noted, however, that free cash flow has been very up and down for Boeing. For the TTM ending March 2010, free cash flow was $4.2 billion. This plummeted to $736 million in September 2011 and then rose back up to $4.2 billion in March 2012. It is this "on and off" kind of business that may deter investors to back the company during the full recovery.
United, on the other hand, has been on more of a consistent rise. Free cash flow has grown from $5 billion in June 2010 to nearly $6 billion in the last 2 years. Assuming the company meets analyst expectations, it will generate 2016 EPS of $8.61 over the next 5 years. At a multiple of 16x, this translates to a future stock value of $137.76. Discounting backwards by 10% yields a present value of $85.54. That's at a significant premium to the current market value and easily merits an investment when combined with double digit and industry-leading ROA, ROE, and ROI.
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