Hexcel (HXL) sells bulk orders of advanced composite materials (80% of revenue), such as carbon fibers, carbon and glass fabrics, and structural honeycomb, explains analyst Colin Scarola in CFRA Research's flagship newsletter The Outlook.
It also manufactures engineered products from its own composite materials for use in aerospace applications (20%), such as aircraft wing panels, helicopter blades, and engine nacelles, or casings.
Our Strong Buy opinion is based on our view that Hexcel has attractive earnings growth potential due to an ongoing long-term trend of replacing traditional metals with advanced composites in a wide variety of engineering applications; and that shares are available at a bargain price due to the market's misunderstanding of, and overemphasis on, Hexcel's relationship to the distressed airline industry.
Hexcel's advanced composite materials provide significant weight and strength advantages over traditional metals like steel and aluminum.
For example, typical studies find that carbon fiber, a key component of many advanced composite materials, is 5x stronger than steel while weighing 80% less—and 10x stronger than aluminum while 40% lighter.
This makes replacing metals with composites desirable from an environmental standpoint — lighter equipment, such as planes, use less fuel and are quieter—as well as from a safety and maintenance standpoint — increased strength and durability reduces mechanical failure rates, making equipment safer, longer-lasting, and requiring less frequent repair.
The desirability of composites in high-performance engineering applications speaks for itself, in our view, but Hexcel's demonstrated ability to lower costs is also a critical aspect of its growth potential.
Despite our view of Hexcel's strong long-term growth potential, its shares have sold off about 40% year-to-date, drastically underperforming the S&P 500 (flat year-to-date).
This is likely due to Hexcel's exposure to commercial aviation end markets, as its shares have tracked closely with the Covid-19 distressed airline industry for most of this year.
Hexcel certainly relies heavily on new commercial plane orders from airlines, as 59% of its 2019 revenue was from commercial sales to plane makers Airbus and Boeing or their suppliers.
However, we think the market has miscalculated in its similar discounting of Hexcel and airline stocks, creating an attractive entry price for investors to partake in the composite maker's long-term growth potential.
Our discounted free cash flow analysis results in a 12-month target of $53 per share, which is approximately 13% above Hexcel's recent price. The $53 target price also equates to 22x our 2021 EPS estimate, above Hexcel's five-year forward P/E average of 20x.
