Thursday, February 7, 2013

BE Aerospace Stock Research

Commercial aerospace company BE Aerospace (NASDAQ: BEAV) delivered a pretty strong set of results recently. It raised guidance and served notice that its backlog of orders plus exposure to wide bodied aircraft deliveries is creating good growth opportunities in 2013. In summary, I like the stock and the trends within aerospace that it is exposed to. However, I consider it to be fairly valued and investors may want to wait for a dip before buying in.

BE Aerospace Flying High

In order to accelerate learning and avoid going over old ground I will note that I’ve previously discussed BEAV in a blog post linked here, and I would strongly recommend that readers take a look at a recent outline of the key trends in the commercial aerospace industry. The conclusion of the latter piece is that there is evidence to believe that the airlines' performance within the economic cycle has become relatively better. If so then the companies that supply them (including BEAV) deserve a re-rating even if they still are cyclically aligned.

Turning back to BEAV specifically, here are its business segments and how it made money in 2012.

Its commercial aircraft operations increased revenues in the quarter by 13.9% with operating earnings up 17.9%. This is impressive stuff and reflects the strength of Boeing (NYSE: BA) and Airbus delivery schedules. BEAV is a preferred seating supplier to both airlines and also sells cabin interiors and a range of products including food and drink equipment.

It also has a lavatory system designed initially for the Boeing 737, which is intended for retrofit for airlines. The system creates additional seating on the plane so it has obvious ROI appeal.  I suspect take-up has been lower than expected, but management stated in the conference call that they expect to receive an order ‘in the near future.’

There are a few key trends to look out for with this segment:

  • Governments are not subsidizing loss making airlines as they did before, so the weight of business has shifted somewhat towards new build rather than retro–fit. Older planes are being retired rather than kept going, but BEAV is forecasting a pick up in the aftermarket by 2014.
  • 61% of BEAV’s revenues were driven by new-build.
  • The trend towards wide bodied airplanes is greatly beneficial to BEAV.
  • The issues with the 787 Dreamliner could be a problem, but for now BEAV have been told to deliver as usual by Boeing.
  • A deal for the lavatory system would really kick-start BEAV’s activities at the airplane assembly and possibly open up new opportunities.
  • Retrofit LED lighting will also provide some growth.

So there are plenty of growth drivers alongside the traditional cyclicality within this segment.

Consumables Management and Business Jets

Consumables revenues rose 28.9% in the quarter, and earnings were similarly up 28.6%. It’s an area where the company has been making acquisitions, and with a cash pile of $514 million don’t be surprised if it makes more in the future. It’s also expecting significant margin expansion as the acquisitions bed in and synergies ensue. One point of note is that consumables demand is largely dependent upon hours flown by its customers, so this division is going to be cyclically aligned with passenger traffic numbers.

However, the super-cyclical segment can be found with Business Jets. Revenues increased 45.8% in the quarter and 77.1% in terms of earnings. This looks great, but it is really being driven by its Super First Class businesses. This is actually good news because it implies that if/when the global economy accelerates its growth then there is upside potential here.

Indeed, Embraer (NYSE: ERJ) recently gave its forecast for its jet sales in 2013. It is predicting 90-95 commercial jet deliveries from 106 in 2012. With regards to business jets, it forecasts 80-90 light executive jets from 77 in 2012 and 25-30 large executive jets from only 22 last year. So regional jet deliveries will be weaker, but executive jets are picking up. This is a good sign for BEAV’s business jet segment, and recall that BEAV is more focused on larger jets than the kind of regional jets that Embraer or Bombardier manufacture.

Where Next for BE Aerospace?

BEAV is forecasting $3.45 in diluted EPS for 2013, which puts them on a forward PE ratio of around 15.1x; for free cash flow, BEAV is predicting 70% of net earnings. This gives a figure of around $248 million or 3.6% of its enterprise value. This is not great, but then this industry is categorized by the need to invest in capital expenditures in order to service contracts.

Putting all this together leads me to conclude that an investment decision is based upon your level of belief in BEAV’s prediction that wide bodied aircraft deliveries will grow at a compound annual growth rate of 14% over the next three years. In turn that depends on the global economy and particularly emerging markets. For those of us a bit cautious on that front (or in my case on China’s growth in 2014-15) I think a larger margin of safety should be priced into this stock before buying in despite its obvious merits.

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