Precision Castparts Corp. (PCP): The Latest Aerospace Play Gives Earnings

Precision Castparts CorpAnother week and another set of earnings in the industrial space that confirms the curious bifurcation in the sector. Companies selling to the aerospace and automotive sectors had a good quarter, while others found things a lot tougher.  Such thoughts came to mind when looking at Precision Castparts Corp. (NYSE:PCP) latest results. In this article I want to delve into the reasons why, and suggest some other stocks in the aerospace sector.

Precision Castparts lifts off

The bifurcation that I spoke of above was further demonstrated in these results. Fortunately for Precision Castparts Corp. (NYSE:PCP)’ investors, the company has increased its exposure to aerospace. It now makes up 67% of revenues, vs. 64% last year.  The Timet acquisition has helped while also allowing it to generate operational efficiencies and synergies.

A quick breakdown of revenues demonstrates the positive effects of Timet on the forged products segment:

And a breakdown of operating income in the quarter shows how it makes its money:

Moreover, there is still plenty of growth to come as it ramps up production (notably by getting its 29,000 ton press back to full capacity by the end of the year) for the The Boeing Company (NYSE:BA) 787 this year. It will do similar with the 737 next year. Fortunately, large commercial aerospace makes up 75% of its market, with military only at 17%. Elsewhere, its other segments saw less than stellar performance, with power falling to 18% of sales from 21% last year, and general industrial remaining flat at 15%.

What the industry is saying

Focusing on the macro aspect of its results, investors need to understand that the commercial aerospace industry is highly cyclical. The good news is that in this cycle the airlines have been surprisingly profitable. I discussed some of the reasons why here.

In summary, I think airline profitability is better this time, due to a combination of factors. Austerity measures have brought about a reduction in the willingness of governments to subsidize loss-making ‘national champions’. At the same time, financing has become harder for new entrants. In addition, the growth in emerging market passengers has created new growth drivers for the industry. And finally, the airlines have had a few years to adjust to high oil prices. The really interesting point is that –past the short term- profitability does not appear to correlate with oil prices. All said, it is a better operating environment for the airlines.

We got a good early read on the current strength of the industry when Alcoa Inc (NYSE:AA) reported results. It was a generally positive set of numbers from its end market perspective. With regards to aviation, Alcoa Inc (NYSE:AA) stuck to its previous bullish guidance of 9-10% global growth this year, with particular strength coming from emerging markets. The issue with Alcoa Inc (NYSE:AA) is not necessarily its end market growth, but rather the state of overcapacity in aluminum production. Its aviation demand remains strong.

Therefore, it is not surprising that Boeing has been beating estimates and looks set to continue. Naturally, the aviation industry will never truly escape being cyclical, but as long as the global economy remains on track, it is a sector that can outperform. This is good news for Boeing, Precision Castparts Corp. (NYSE:PCP), and other players like cabin manufacturer B/E Aerospace Inc (NASDAQ:BEAV).

The latter is one of the most interesting names in the aerospace sector, and offers a rare way to get pure exposure to commercial aerospace. Its growth prospects rely on a mix of retrofit a,d new build demand. In addition, it is a key beneficiary of the trend towards wide bodied aircraft, and has a number of new innovations, like its lavatory system for the 737 which allows airlines to gain a few extra seats. However, I think its key plus point relates to the profitability of airlines. If the industry is on a more sustainable path, then airlines will be better positioned financially in order to retrofit planes, rather allow them to depreciate.

Where next?

On a stock specific basis, this means that companies like Precision Castparts Corp. (NYSE:PCP) can continue to outperform. It offers a combination of upside from a ramp-up in production, plus synergy opportunities. Both activities can increase margins going forward.  Similarly, something like B/E Aerospace Inc (NASDAQ:BEAV) is going to benefit from more favorable industry financials. The Boeing Company (NYSE:BA) is an obvious momentum play. If you are bullish on the global economy and particularly emerging markets, then all these stocks represent attractive propositions.

The article The Latest Aerospace Play Gives Earnings originally appeared on Fool.com and is written by Lee Samaha.

Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends Precision Castparts. Lee is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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