BE Aerospace, Set to Fly Higher?

Shareholders in airplane cabin manufacturer B/E Aerospace    watched their stock rise more than 75% in 2013, so the recent sell-off shouldn't come as a surprise. Unfortunately, stocks can't go in one direction forever. The question facing investors now is whether the recent fall presents a buying opportunity or not?

B/E Aerospace still headed for a great year
First things first, there was nothing in B/E Aerospace's recent fourth-quarter results to suggest that the company is not going to have a great year in 2014. Although, internal EPS guidance of $4.25 was below analyst consensus of $4.34, it still represents earnings growth of nearly 20%. Moreover, the International Air Transport Association, or IATA, recently upgraded its forecast for airline profitability in 2014.

The industry backdrop looks positive. More airline profitability usually means more spending on new planes and retrofitting of older aircraft too. It's all good news for B/E Aerospace.

Growth initiatives
In addition, the company recently announced a number of growth initiatives:

• A contract enhancement with United Technologies  to supply fasteners, hardware, logistics, and consumables to its aviation units. B/E estimates the deal has a value of $950 million to 2022

• A contract with helicopter manufacturer AgustaWestland to provide logistics and consumables. The deal's estimated value is $200 million, and goes till 2018.

•  Its modular lavatory system (shaped to create additional seating on planes) is now being shipped to Boeing   with 14 Boeing 737s in service with the system. More growth is expected as Boeing's demand is expected to increase.

• In a departure from its core activity, B/E made two acquisitions in the oil and gas consumables market. 

The contract announcements were obviously good news, and the ramp up in lavatory systems shipments (the first system was shipped as recently as the third quarter) is a confirmation of strong demand for an exciting new product.

However, the move into the oil and gas consumables market is more subject to scrutiny. When questioned on the conference call, B/E's CEO, Amin Khoury, argued that the oil and gas consumables services business is four times the size of its opportunity in aerospace, and is growing twice as fast with similar margins. Moreover, he sees it as reducing the volatility in the business, because prospects for oil and aerospace are inversely related.

Unfortunately, this argument looks weak. The reality is that airline profitability is cyclically based on the economy, and the price of oil is too. Moreover, airlines have got a lot better at dealing with high oil prices then in the past. All told, the move looks likely to increase cyclicality rather than reduce it, but this doesn't mean it is a bad idea!

Valuation, valuation, valuation
All told, BE is headed for a strong year, but the problem is that its valuation has largely priced this in. In order to look at the kind of assumptions made in its stock price, consider that BE only converted 61% of its net earnings into free cash flow in 2013, and management forecasts only around 65% for 2014.

Assuming that 65% of earnings are converted into free cash flow on a long-term basis, and plugging in analyst estimates to 2017, gives the following estimate of its free cash flow. Its current share price is $79.4 with an equivalent enterprise value (market cap plus debt), or EV, of $96.

Source: Nasdaq.com

Unless its free cash flow conversion gets markedly better in future years, or its earnings are better than consensus forecasts, it's hard to see how B/E is a good value. Indeed, B/E has struggled with cash flow conversion in the past. The essence of the issue is that working capital requirements and inventory always goes up in order to service new orders.

Where next for B/E Aerospace?
The valuation doesn't look cheap and the assumptions needing to be made in order to make it look cheap are relatively optimistic. Based on the IATA outlook, there is certainly good reason to expect commercial aerospace to outperform in 2014, but who can predict where the economy will be in 2017?

Moreover, Fools need to appreciate that even if Boeing and Airbus have historically strong order books, if the economy turns down then orders will be cancelled and B/E will suffer. You can never fully discount risk. As attractive as the company undoubtedly is, it's hard to make a case for it based on anything other than earnings momentum

Commercial Aerospace Looking Good For 2014

Last year was a bumper year for equities, but it wasn't a great one for the economy. However, the commercial aerospace sector stood out, because according to the International Air Transport Association, or IATA, end market conditions progressively improved through 2013. Moreover, the IATA is forecasting an even better year in 2014, so prospects for commercial aerospace plays like Boeing (NYSE: BA  ) , cabin manufacturer BE Aerospace (NASDAQ: BEAV  ) ,aviation services company AAR Corp (NYSE: AIR  ) and airframe product manufacturer Precision Castparts (NYSE: PCP  ) are looking good, too.

IATA Industry Forecasts
The following graph demonstrates how the IATA's expectations for commercial airline profitability in 2013 progressively got better through the year. Meanwhile, its forecast for world economic growth actually declined over the period. In September of 2012, the IATA forecasted world economic growth in 2013 to be 2.5%, while the latest forecast from December of this year was just 2%. http://www.iata.org/whatwedo/Documents/economics/IATA-Economic-Briefing-Financial-Forecast-December-2013.pdf

Source: IATA.

Moreover, its latest forecast for 2014 sees global net profits expanding to $19.7 billion from 2013, an increase of 52%. Among these improvements, there is a remarkable turnaround taking place in terms of regional prospects.

Back in 2010, Asia-Pacific airlines generated $11.1 billion in profit, while North American airlines only made $4.2 billion. However, the IATA is forecasting North American airline commercial airline profits to increase to $8.3 billion in 2014 from $5.8 billion this year. Meanwhile, Asia-Pacific commercial airline profits are forecast to be only $4.1 billion in 2014.

The obvious answer would be that passenger traffic growth must have gone up, but according to the IATA, North American growth isn't going up by much, and is still noticeably less than in the Asia-Pacific region.

Source: IATA.

So how and why have North American (and to a lesser extent European) airlines suddenly become more profitable, and how can Foolish investors take advantage?

More pricing power, more efficiency
There are two primary reasons for this increased profitability. First, North American airlines are seeing greater pricing power thanks to a slowly improved economy. Second, they are taking substantive productivity measures to increase profitability. These two factors will combine to drive growth in the future.

You can see the pricing power in the fact that the IATA forecasts that global net profit per departing passenger in 2014 will be at $5.94 in 2014 -- a level not seen since the peak of 2007. Western airlines' willingness to improve productivity includes buying more modern and efficient planes from Boeing and Airbus. It's significant that the airlines placing the largest orders for Boeing planes as of mid-December this year were American Airlines and European budget carrier Ryanair, with 143 and 175, respectively, out of Boeing's total of 1074. Furthermore, Boeing can look forward to a strong order book in 2014 because the IATA predicts that overall passenger load factors (a measure of airplane capacity utilization) will rise to 81.3% in 2014. In other words, capacity pressures are likely to encourage more investment in new airplanes.

Source:IATA.

BE Aerospace, Precision Castparts, and AAR Corp BE Aerospace is also a key beneficiary of the upswing in commercial aerospace. Not only does it offer newbuild cabins, but its retrofit orders should also increase as airlines become more profitable. In addition, at its last results, BE Aerospace announced the first delivery of its modular lavatory system on a Boeing plane delivered to Delta Airlines.

Precision Castparts has invested heavily in preparation for the upswing, and appears to be ready to realize the fruits of its investment. Precision bought longtime Boeing supplier TIMET for $2.9 billion in 2013. .  Furthermore, Precision has been investing in ramping up production capacity for the Boeing 737 and 787 Dreamliner. Given that these two airplanes have received 74% and 17% of Boeing's total net orders for the year to Dec 2013, it looks like a smart move.

AAR Corp helps airlines improve productivity by allowing airlines to outsource logistics and spare parts provision. AAR is clearly looking to expand its supply chain activities. According to CEO, David Storch on its recent conference call:

So as we think about the supply chain piece itself, one of the things we'd like to do is build out, and we've talked about this before, geographic expansion. And we are looking at a fairly sizable deal that would expand our presence

However, AAR makes less than two-thirds of its sales to commercial customers  with the rest going to defense and government customers. It's not really a pure-play commercial aerospace company, but it is nicely exposed to airlines seeking to cut costs.

The bottom line
Prospects look good for the commercial aerospace industry in 2014, and provided the global economy holds up, the sector has the opportunity to outperform. North American airline profitability is leading the way, and Foolish investors would we will advised to look at companies servicing demand from them. The commercial aerospace upswing isn't over yet.

What GE's Results Say About the Sectors You Should Invest In

Industrial conglomerates like General Electric (NYSE: GE  )  make good bellwethers for different sectors of the global economy -- and if its most recent quarter's any judge, the economy's looking pretty good. 

GE reports broad-based strength

With the sole exception of health care services, each of its six industrial segments reported growth in equipment and services orders. 

The most surprising aspect of GE's report was how strong its power & water segment orders were. The segment has been GE's Achilles' heel this year, but wind units posted strong results, with 477 orders vs. 87 last year. Moreover, GE expects fourth-quarter power & water orders to come in at the higher end of its previous guidance. 

Source: Company presentations.

While it was posted a strong quarter all around, GE's quarterly results always need to be put into the context of ongoing trends, because big-ticket capital machinery sales tend to be lumpy at the best of times.

The key takeaways from GE's third-quarter results

 While this quarter saw broad-based growth, there have been four consistent areas of strength in GE's results throughout the year.

• Commercial aviation
• US home appliances
• Emerging-market health care
• Global transportation

GE's aviation revenue was up 12% in the quarter, but this increase belies a clear distinction between commercial and military aviation. For example, its military orders were down 30% in the quarter. In fact, this story has been replicated throughout the year, as investors have played a game of trying to find the aviation stocks whose revenue is weighted toward commercial aviation.

One obvious beneficiary of this trend is a company like B/E Aerospace (NASDAQ: BEAV  ) . The company makes commercial aircraft cabins, and the stock has soared 57% year to date on the back of record order books at Boeing and Airbus.

Moreover, BE Aerospace just reported its own record order book of $900 million in the quarter, and it announced the first delivery of its modular advanced lavatory system. While that doesn't sound glamorous, the toilet gives airlines a few extra seats on their planes, which could help them increase revenue for each flight for years to come.

GE also announced that household appliances within its home & business segment increased 11% -- an ongoing source of strength. Similarly, Whirlpool has twice upgraded its expectations for end demand from the US.

This must be good news for the home improvement stores like Home Depot or Lowe's Companies (NYSE: LOW  ) . Not only is the current upturn in the housing market helping out spending at Lowe's, but investors need to recall that we are coming up against the 10-year anniversary of the housing boom. In other words, Lowe's should start to see customers coming in and looking to replace white goods that they bought at the peak of the boom. Moreover, Lowe's is strategically resetting its product lines, which is a lot easier to do when markets are picking up.

The third key takeaway is that emerging markets offer far better growth prospects for health care companies. Within its health care segment, GE's developed markets grew 1%, while the emerging markets grew 14% with 33% in China alone. This is a clear sign that investors should be favoring a company like Covidien (NYSE: COV  ) , which can outgrow its health care markets. Covidien's big plus is that its products aren't big-ticket items -- an important quality when selling to emerging markets. Moreover, it can demonstrate a tangible return on investment with things like minimally invasive surgery, and its key endo-mechanical  and energy products still haven't gained much of a presence in emerging markets.

Where next for General Electric?

In conclusion, it was a pretty good quarter for GE, and the return to strength of its power & water segment confirms it's on track to hit analyst earnings estimates of $1.63 this year. This would put the stock at P/E ratio of around 16 -- not a bad value for a stock with a near-3% dividend yield and a good chance of growing faster than GDP over the next few years.

Precision Castparts Offers Leverage to the Global Economy

Another week and another set of earnings in the industrial space that confirms the curious bifurcation in the sector. Companies selling to the aerospace and automotive sectors had a good quarter, while others found things a lot tougher.  Such thoughts came to mind when looking at Precision Castparts'  latest results. In this article I want to delve into the reasons why, and suggest some other stocks in the aerospace sector.

Precision Castparts lifts off

The bifurcation that I spoke of above was further demonstrated in these results. Fortunately for Precision Castparts’ investors, the company has increased its exposure to aerospace. It now makes up 67% of revenues, vs. 64% last year.  The Timet acquisition has helped while also allowing it to generate operational efficiencies and synergies.

A quick breakdown of revenues demonstrates the positive effects of Timet on the forged products segment:

And a breakdown of operating income in the quarter shows how it makes its money:

Moreover, there is still plenty of growth to come as it ramps up production (notably by getting its 29,000 ton press back to full capacity by the end of the year) for the Boeing 787 this year. It will do similar with the 737 next year.  Fortunately, large commercial aerospace makes up 75% of its market, with military only at 17%. Elsewhere, its other segments saw less than stellar performance, with power falling to 18% of sales from 21% last year, and general industrial remaining flat at 15%.

What the industry is saying

Focusing on the macro aspect of its results, investors need to understand that the commercial aerospace industry is highly cyclical. The good news is that in this cycle the airlines have been surprisingly profitable. I discussed some of the reasons why here.

In summary, I think airline profitability is better this time, due to a combination of factors. Austerity measures have brought about a reduction in the willingness of governments to subsidize loss-making ‘national champions'. At the same time, financing has become harder for new entrants. In addition, the growth in emerging market passengers has created new growth drivers for the industry. And finally, the airlines have had a few years to adjust to high oil prices.  The really interesting point is that –past the short term- profitability does not appear to correlate with oil prices. All said, it is a better operating environment for the airlines.

We got a good early read on the current strength of the industry when Alcoa  reported results.  It was a generally positive set of numbers from its end market perspective. With regards to aviation, Alcoa stuck to its previous bullish guidance of 9-10% global growth this year, with particular strength coming from emerging markets. The issue with Alcoa is not necessarily its end market growth, but rather the state of overcapacity in aluminum production. Its aviation demand remains strong.

Therefore, it is not surprising that Boeing has been beating estimates and looks set to continue. Naturally, the aviation industry will never truly escape being cyclical, but as long as the global economy remains on track, it is a sector that can outperform. This is good news for Boeing, Precision Castparts, and other players like cabin manufacturer BE Aerospace.

The latter is one of the most interesting names in the aerospace sector, and offers a rare way to get pure exposure to commercial aerospace. Its growth prospects rely on a mix of retrofit and new build demand. In addition, it is a key beneficiary of the trend towards wide bodied aircraft, and has a number of new innovations, like its lavatory system for the 737 which allows airlines to gain a few extra seats. However, I think its key plus point relates to the profitability of airlines. If the industry is on a more sustainable path, then airlines will be better positioned financially in order to retrofit planes, rather allow them to depreciate.

Where next?

On a stock specific basis, this means that companies like Precision Castparts can continue to outperform. It offers a combination of upside from a ramp-up in production, plus synergy opportunities. Both activities can increase margins going forward.  Similarly, something like BE Aerospace is going to benefit from more favorable industry financials. Boeing is an obvious momentum play.  If you are bullish on the global economy and particularly emerging markets, then all these stocks represent attractive propositions. 

BE Aerospace Flying High

Commercial aerospace stock BE Aerospace gave results today and were initially marked down, only to come back stronger in the day. The stock is interesting to research and report on, because it is one of the very few stocks in the sector with a focus on commercial aerospace. Therefore, you can avoid the vagaries of the effects of austerity measures on defence spending.

BE Aerospace is the world's leading supplier of aircraft cabins and interiors, with the main rival being Zodiac Aerospace of France.  It is also the global number one distributor of aerospace fasteners and consumables. In short, the more passenger air miles that are flown, the more wear and tear, and ultimately the more airlines need to replace equipment. With fasteners, it is ongoing. However, with things like cabin interiors the end demand is subject to upgrade cycles and new purchases.

Turning to the results.

BE Aerospace Q4 and Full Year Results

Results

• Q4 revs of $541.9m vs. $526.4m estimates
• Q4 adj diluted EPS of 47c vs. 40c estimates

Guidance

• Full year revs of $2.4bn vs. $2.4bn estimates
• Full year diluted EPS of $1.95 vs. $1.97bn

The book to bill ratio is now 1.1 and quoting from the results statement

'Currently, a number of factors that significantly influence our business are positive. The global economy, a key factor in driving global passenger traffic, continues to recover. As a result, the global airlines are experiencing strong growth in revenues, profitability and liquidity. Growing passenger traffic is driving smart capacity increases and higher aircraft utilization. In addition, due to record wide-body backlogs at the major OEM's, wide-body aircraft deliveries are expected to grow at an approximately 74 percent higher average rate as compared to 2010 deliveries each year from 2011 to 2014 and to continue to catalyze retrofit activity'

so the company has good earnings momentum from wide body aircraft growth, increasing passenger traffic and growth in new build.


A Two Speed Aerospace Market

As with much of the global economy, the growth is coming from emerging markets and, in particular, India and the Far East. The need for growth in the provision of inter city air traffic in these countries goes on unabated. BE Aerospace is well placed in the Far East, having announced that the company won $200m of orders from China in 2010. Wide body aircraft sales are growing with the increasing trend towards major hub-to-hub air traffic. Another area of growth comes from the budget airlines, who have supported new aircraft orders in Europe over the last few years.

However, what will ultimately guide the stock price is global passenger growth...

%	2001	2002	2003	2004	2005	2006	2007	2008	2009	2010E	2011E
OECD growth	1.2	1.7	2	3.2	2.8	3.1	2.7	0.3	-3.4	2.8	2.3
Passenger growth	-2.7	1	2.3	14.9	7	5	6.4	1.5	-2.1	8.9	5.2

Source: IATA, OECD
...and this seems to be capable of generating growth in excess of global GDP. The industry was hit hard after 9/11 but has recovered strongly.


BE Aerospace Earnings
Turning to how industry growth blends into BE Aerospace earnings. In terms of revenues...

 

(m)	2006	2007	2008	2009	2010
Revenue	1128	1677	2110	1937	1984
Gross  Profit	425.9	570.1	723.5	669.2	720.5
margin	37.8%	34.0%	34.3%	34.5%	36.3%

Source: BE Aerospace, Earnings View

...and looking at the last five years for BE Aerospace...

(m)	2006	2007	2008	2009	2010
Pre-Tax Profit	90	215.5	302	204.6	211.6
WC Movement	-105	-241.9	-234.2	-182	12.4
Op Cash Flow	41	22	115.5	82.3	295.8
OCF/Pre-Tax	45.6%	10.2%	38.2%	40.2%	139.8%
Depreciation	29	35	40.7	49.5	52.4
Capex	24.1	32.1	31.7	28.4	68.9
capex/dep	83.1%	91.7%	77.9%	57.4%	131.5%
FCF	16.9	-10.1	83.8	53.9	226.9
FCF/EV	0.4%	-0.2%	1.8%	1.1%	4.8%

Source: BE Aerospace, Earnings View
...the pattern is clear. BE Aerospace always adverse working capital movements when in the growth phase. This is completely natural but, it does mean that an investor will have to assess the cyclical nature of BE Aerospace growth in his calculations.


BE Aerospace a Stock to Buy?

Ultimately taking a view on BE Aerospace as a stock to buy will depend upon taking a positive outlook for passenger growth. Furthermore, that growth is skewed towards wide body aircraft and emerging market air travel. These are both positive drivers and BE Aerospace appears set for good long term growth. Indeed, 2012  forecasts are for revenues of $2.4bn and EPS of $1.95 and free cash flow is forecasts at $196m.

 If we accept the 2012 free cash flow forecast it will mean that BE Aerospace has generated $567m in free cash flow over the last six years. The current share price is $37.85 giving a market cap of $3.87bn and an enterprise value of $4.63bn. Frankly, I think this rating is fairly priced for the longer term risk. Whilst growth looks assured for 2011, there are still concerns over asset class bubbles in China and BE Aerospace-although attractive- is not priced cheaply enough for this risk.



Source:

IATA Outlook