Update Precision Castparts with a higher target after a big acquisition

11/12/2012 5:10 pm EST


Jim Jubak

Founder and Editor, JubakPicks.com

Usually, when a company makes an acquisition bid, the shares of the acquiring company take a hit. That’s certainly what you would expect when the acquirer offers a 44% premium. But today shares of Precision Castparts (PCP) are up 4.6% (as of 3 p.m. New York time) on news that it will buy Titanium Metals (TIE) at a 44% premium in an all-cash offer.

Wall Street really likes this deal. And there’s a lot to like. (Precision Castparts is a member of my Jubak’s Picks http://jubakpicks.com/  )

Precision Castparts makes components for jet engines and for industrial gas turbines. I’ve liked the stock on the fundamentals of those two businesses even before this acquisition. Boeing (BA), a major customer (as is Airbus, General Electric (GE), Rolls-Royce and Pratt & Whitney) is finally ramping its production of its new 787 Dreamliner from four per month to a scheduled 10 a month by the end of 2013. (Production hit five per month in October.) Both Boeing and Airbus show a six-year backlog of orders. (In the other major part of its business, orders for gas turbines are improving as the U.S. economy gradually recovers and continued low prices for natural gas make it an attractive fuel for new power plants.)

Both aircraft manufacturers are doing everything they can to streamline the global supply chains that have been such a big part of problems in increasing monthly production rates. The good news there for Precision Castparts is that streamlining means concentrating more orders with larger suppliers that have been able to deliver on schedule.

The acquisition of Titanium Metals plays into this scenario in two ways. First, it makes Precision Castparts an even more critical supplier to Boeing and Airbus. Adding the titanium sponge, melt and mill capacity of Titanium Metals increases Precision Castparts vertical integration by giving the company ownership of one of three domestic titanium mills. Precision Castparts has solid experience with this kind of vertical integration from its 2006 acquisition of nickel producer SMC. The acquisition of Titanium Metals fills major holes in the Precision Castparts line up when measured against competitors such as Allegheny Technologies (ATI.)

Second, Precision Castparts is acquiring a titanium producer just as the titanium content in new generation aircraft is taking off. Current generation twin-aisle aircraft such as the Airbus 320 and the Boeing 737 use an average of 48 metric tons of titanium per airplane, according to Credit Suisse. Boeing’s 787 uses 116 metric tons. That trend toward increased use of titanium is likely to continue since the material’s strength and light weight make it compatible with increased use of weight-saving composites in future aircraft.

With money cheap in the current market—Precision Castparts will pay about 4.5% on the debt that it sells to fund this deal, Credit Suisse estimates—and with sizeable synergies in the deal (Precision Castparts accounts for 16% of Titanium Metals’ sales)—I think this acquisition will add something between 50 cents a share and $1.00 a share to Precision Castpart’s earnings in the 2014 fiscal year that ends in March 2014. That works out to a target price of $208 a share by May 2013, up from my current $195 a share target. That’s a roughly a 16% potential gain in six months. (The shares pay a 0.7% dividend.)

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Precision Castparts as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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