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Morningstar | Because I’m T.X.T., I’m Dynamite: Textron Beats Thanks to Lower Taxes and Business Jet Growth

No-moat Textron reported first-quarter results that beat consensus and featured year-over-year EPS growth of 6% thanks largely to a lower-than-expected tax rate that won't repeat. However, segment operating profits did increase in the quarter despite the tools & test divestment. Manufacturing cashflow was a weak spot coming in at negative $291 million versus negative $158 million last year, which we think can be put down to inventory build (probably the Longitude). Although Textron turned in a solid quarter, management didn’t move guidance and we’re maintaining our fair value estimate of $55.

The Aviation business (business jets and turboprops) drove growth this quarter with revenue rising 12% on the back of higher jet deliveries (44 versus 36 in first-quarter 2018) and more turboprops (44 versus 29). More importantly, operating margins expanded at the Aviation segment by 220 basis points thanks to operating leverage and pricing. However, all of Textron’s other units shrunk year over year, which contributed to our decision to sit on our 2019 forecast. Bell delivered fewer commercial helicopters this quarter (30 versus 46) but margins moved up year over year. That said, we anticipate sequential margin declines at Bell during the back half of 2019 as less favorable V-22 economics set in. More concerning was the Industrial segment, where revenue dropped 9.1% even after excluding divestments. The Systems business also shrank 21% year over year due to lower ground vehicle and unmanned systems volumes, and operating margins contracted 380 basis points, noting a very tough comparable of 12.9% last year.

Management confirmed 2019 guidance, which includes 0%-1% revenue growth (about 4.5% after controlling for divestments per our estimates) coupled with $3.65 EPS at the midpoint. The ongoing Arctic Cat turnaround and the Longitude's certification from the Federal Aviation Administration, which has taken longer than planned, remain two key pacing items for us.

The specialized vehicle business line, which houses Arctic Cat, turned in sequentially better profit this quarter, while the Longitude’s FAA certification is, unfortunately, still pending. Textron planned for a handful of Longitude deliveries this quarter, but we think that if the aircraft is certified during the second quarter the company can catch up, clear out inventory, and meet full-year guidance.

Lastly, we're monitoring the ship-to-shore connector, or SSC, program, which has faced delays and cost challenges. Textron is currently booking zero margins on the fixed price development contract linked to the program. In response, the Navy cut its planned procurement for the program in its fiscal 2020 budget request and in the Future Years Defense Plan it submitted. Textron will undoubtedly lobby Congress to reinstate SSC funding for fiscal 2020, and we think the company may be successful given the Congressional support the program enjoys. Indeed, in fiscal 2019 Congress appropriated funds for eight SSCs, three more than requested by the Department of Defense.