Best Ideas Newsletter portfolio holding Precision Castparts (click ticker for report: ) reported solid fiscal third-quarter results Thursday that showed strong top-line and operating-income expansion and left us feeling quite optimistic about its recently-announced acquisition of Titanium Metals (TIE). We’re raising our fair value estimate for Precision Castparts to $246 per share (was $200) on the basis of better future margin forecasts associated with the deal.
The metal-bender’s sales advanced 13% from the year-ago period, while consolidated segment operating income jumped at the same pace. Though the firm’s 25.5% operating margin was flat from the year-ago quarter, the most recently-reported period included $18 million in higher corporate and financing expense from its acquisitive activity.
For investors in micro-cap peer (and Best Ideas portfolio holding), EDAC Technologies (click ticker for report: ) we highlight the level of Precision Castparts’ operating margin (mid-20s) and think EDAC Technologies’ 10.8% operating margin posted in its third-quarter has significant room for further expansion. Margin expansion thanks to integrating Titanium Metals will be a huge profit driver for Precision (similar to the impact of Special Metals), while increasing throughput and cost-containment will be the driver behind EDAC’s margin expansion. We hold both companies in the portfolio of our Best Ideas Newsletter.
Revenue in Precision Castparts’ investment cast products segment advanced 5% from the year-ago period thanks to continued strength in aircraft build rates. The firm also noted that industrial gas turbine sales jumped more than 20% from the same quarter last year. Incremental margins (or the margin on the next sales dollar generated) are in excess of 50% in this segment, suggesting the potential for organic margin expansion remains material as well (the segment’s operating margin was 34.1% of sales during the quarter). The company’s forged products segment saw sales increase 9%, while revenue jumped 32% in its airframe products division thanks to 13% organic expansion.
We cannot overstate the potential margin expansion associated with Precision Castparts’ Titanium Metals acquisition. CEO Mark Donegan is perhaps the most talented CEO in our entire coverage universe in extracting efficiencies and cost-savings from newly-acquired entities, and we think he will deliver in a big way with Titanium Metals. We are very confident that management will exceed its estimate for deal synergies of $80-$100 million within the first 24 to 36 months. Impressively, Donegan stated the integration has already begun in “full force.” We’re not sweating Boeing’s (BA) problems with the 787 as it relates to the aerospace supply chain and are expecting solid performance from both Precision Castparts and EDAC Technologies in the coming years.