Aerospace Cycles Rise for Textron

12/06/2013 7:00 am EST

Focus: STOCKS

Out latest Focus Stock is an aerospace and defense-focused industrial conglomerate company; it owns iconic aerospace industry brands Cessna Aircraft and Bell Helicopter, notes S&P Capital IQ equity analyst Eric Hugel in The Outlook.

We see Textron (TXT) as a business with solid long-term growth. Recently, sales and earnings disappointments at the Cessna and Bell units have resulted in the stock currently trading at a significant discount to its peers.

While we believe this discount is understandable, we view the issues at Textron as largely cyclical and transitory in nature, and we think the discount will diminish over time, as conditions improve over the next couple of quarters.

The Bell business has been working through a troublesome enterprise resource planning system implementation since the beginning of 2013.

While we expect some lingering impact of these issues over the next couple of quarters, we believe Bell's underlying military and commercial rotorcraft businesses are solid and we expect to see margins and aftermarket part shipments improve going forward.

At Cessna, we believe that we are currently at, or near, the bottom of the demand cycle for small and medium-sized business jets, while at the same time, at the top of Cessna's new product development cycle.

The combination of the timing of these two-cycle dynamics has served to depress Cessna's earnings severely over the past several quarters, but we believe they have not impacted the business' long-term earnings power.

In fact, we see Cessna emerging from the bottom of this cycle with a largely modernized and refreshed product line, which we believe will attract new customers and help retain existing ones.

We estimate EPS will decline 10% to $1.77 in 2013, and rebound 30% in 2014 to $2.30, as many of the transitory headwinds faced in 2013 subside and pension costs decrease.

Our 12-month target price of $35 is based on applying the S&P Aerospace & Defense Select Industry Index's (XAR) current 2014 P/E multiple of 15.4 to our 2014 EPS estimate of $2.30 for Textron.

We see the stock's discount to the index narrowing further over the next couple of months as Cessna actually begins to deliver its new aircraft models and shows stabilization in the Bell businesses. Textron carries S&P Capital IQ's highest investment recommendation of five-stars or strong buy.

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