Call it luck. Call it experience. Call it what you will, but we removed Precision Castparts (PCP) from the Best Ideas portfolio in late September at nearly $240 per share, roughly 20% higher than current levels.
Now one of our favorite watch list ideas, the metal bender said in a regulatory filing released January 16 that its third-quarter fiscal 2015 results would come in a bit light due primarily to lower demand from the oil and gas end markets. The executive suite also pointed to de-stocking from a single commercial aerospace customer, year-end customer inventory management actions, and an extended equipment upgrade as reasons for why revenue would come in the range of $2.42-$2.47 billion and earnings per share from continuing operations in the range $3.05-$3.10 during its fiscal third quarter, below expectations.
The sudden dislocation in the power generation markets is obviously the cause for the quarterly misstep. We think management knew several weeks before quarter-end that it wouldn’t make its quarterly numbers, and as a result, likely saw little need to push its aerospace customers to make up the energy end-market shortfall. Therefore, the fiscal third quarter, in our view, turned out to be similar to what one might see with a “big bath” charge, for example, and we think Precision will make up any revenue and earnings shortfall as it rounds out fiscal 2015 and into fiscal 2016. In fact, management has already acknowledged that momentum in aerospace continues and that it has already started delivering inventory that had been deferred. In anticipation of the quarterly miss, management seems to have shifted some revenue and earnings into the fiscal fourth quarter.
Still, the fact that the power generation markets, which represent just 20% of Precision Castparts’ total business, caused a quarterly miss is a rather big deal. More than two thirds of the company’s revenue is tied to aerospace, which continues to be supported by multi-year backlogs at the airframe makers, Boeing (BA) and Airbus (EADSY). Aerospace-related castings, fasteners, and forgings remain its bread-and-butter product line-up, and overwhelm other aspects of its business. The power generation markets throwing Precision Castparts a curveball is something worth paying attention to, especially when considering incremental growth in fiscal 2016 and fiscal 2017.
The news from Precision Castparts seconds as a major red flag for ~15% customer General Electric (GE), and we may see difficult fourth-quarter results from the industrial giant as well. The right question to ask, however, is whether poor results from GE are already factored into its share price, and we’d argue that they already are. Under these conditions, even a poor report from GE could send its shares higher as it reduces some uncertainty. We continue to hold GE in both newsletter portfolios. GE reports January 23.
On the other hand, we see no reason to extrapolate Precision Castparts’ fiscal third-quarter results to the broader aerospace industry, which remains very healthy. We won’t be adding Precision back to the Best Ideas portfolio anytime soon, and we point to some savvy profit taking late September as the key reason why we’re keeping our heads up on the name. Remember: A good call locks in profits. That’s exactly what we did.
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