Precision’s Path to Growth Anything But Predictable

11/07/2011 4:02 pm EST


Jim Jubak

Founder and Editor,

Shares of Precision Castparts (PCP), a Jubak’s Picks portfolio member, have seen big volatility since the release of fiscal second-quarter earnings on October 27.

The stock first fell from $172.63 a share on October 26 to $158.18 on November 1, an 8.4% drop. Since then, the shares have moved up 5.4% as of 1:25 p.m. on November 7 in New York. That leaves the stock down 3.4% from its pre-earnings price.

So what’s going on? Profit-taking, mostly. Tinged with a little disappointment that the company didn’t blow out earnings in the fiscal second quarter.

And since Precision Castparts doesn’t give guidance when it announces its quarterly results, investors had to do their own calculations to see what the company’s future looks like. Quite a few, it seems, decided to sell rather than do their homework. That’s not unexpected for a stock with a large contingent of momentum investors in its shareholder base.

If you’re a fundamental investor, on the other hand, and cranked the numbers, I think you’re buying on weakness rather than selling.

For the quarter, Precision Castparts announced earnings of $2.03 a share. That missed Wall Street projections by a penny. Revenue climbed by 19% from the second quarter of fiscal 2011 (the September 2010 calendar quarter). That took revenue to $1.8 billion, versus the Wall Street consensus of $1.76. Operating margins were flat year-to-year at 24%.

Absent guidance from the company, I think a lot of investors decided to sell on the news. But I think they’re missing some really good stuff that’s clearly coming down the road in the next few quarters.

Boeing (10% of sales) has finally started to expand production of its long-delayed 787 Dreamliner. It has announced that it will increase production of the existing 737 plane by 1/3 in order to reduce a seven-year backlog. (A recently announced new 737 MAX, set for initial delivery in 2017, has already garnered 600 orders in four months.) And it is considering increasing production of its 777.

All this adds up to lots or orders from engine markers such as General Electric (GE) (and 12% of sales), United Technologies (UTX), and Rolls-Royce—and from plane makers such as Boeing (BA) itself—for the cast parts that the company makes for jet engines and airframes. (Precision Castparts is the world’s largest maker of structural castings for jet engines and makes castings for every jet engine in production or under development.)

Even the company’s long-depressed aerospace fasteners business is finally showing signs of life. Aerospace sales climbed 27% in the just-reported quarter.

What’s intriguing to me about Precision Castparts right now is that the company is getting this kind of revenue growth—19% for the quarter—with only the aerospace business running at anything like full speed.

Precision Castparts also makes seamless pipe for the energy industry—that unit saw flat sales year to year—and its energy business—the same turbine technology used in jets is also used in power plants—saw just 7% revenue growth.

Both of those businesses are, however, starting to show signs of life. Sales of pipe to the oil and gas industry are improving, and Precision Castparts is about to begin initial shipments to Saudi Aramco following initial qualification as a supplier.

The turbine unit is seeing more demand from natural-gas-fired power plants, but less from coal-fired plants—that would probably just balance out, except that new turbines are including more Precision Castparts content.

All this adds up to 19% revenue growth for the fiscal year that ends in March 2012, and 16% for the year that ends in March 2013, according to projections by Credit Suisse. And to an increase in operating margins to 30% to 35% (from the recent 24%) in the last two quarters of fiscal 2012.

The shares currently trade at 21.7 times trailing 12-month earnings per share and 19.7 times projected fiscal 2012 earnings. That’s very reasonable when you look at projected earnings per share growth of 21%.

I’d put a new target price of $195 a share on these shares by June 2012. That’s a projected 17% return in eight months, and slightly up from my prior target of $192 by May 2012.

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, 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 June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio here.

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