EUR 850.00 For Business Accounts Only

Morningstar | Textron Reports Solid 2Q and Raises Guidance, but We Still Think Shares Are Overvalued

No-moat Textron reported second-quarter results that beat consensus expectations, and operating margins were up year over year. The increase in margins was driven by aviation, which had a tough second quarter last year but recovered this year on the back of more pricing discipline and a better product mix. Going into the call, we were at the high end of earnings per share guidance ($3.13), but Textron added $0.20 to its outlook for a new EPS range of $3.15-$3.35. The one-time gain of $400 million expected in the third quarter of this year linked to the tools and test divestment is not included in the update. Free cash flow guidance moved up $50 million to a new midpoint of $775 million for 2018.

We anticipate increasing our $55 fair value estimate due to an improved 2018 outlook, but since we’re not changing our forecast for normalized operating margins and cash flows, which already sits well above current levels, the valuation increase will only be about $2. Although we think the helicopter market is finally firming up and expect a sustainable recovery in business jets to finally take hold toward the end of this year, we continue to view Textron’s shares as overvalued at current levels, trading at a price/fair value above 1.

In our discounted cash flow model, we forecast Textron expanding its operating margins to 9.7% by 2020, roughly 140 basis points higher than its all-time high. We anticipate operating margins hovering around 9.7% after 2020 and use this level of profitability for normalized margins. To arrive at where shares are currently trading, we need to assume normalized operating margins north of 11% in our valuation. We don't think this is achievable over the long term, given the cyclical nature of the commercial helicopter and business jet markets, combined with the ramp-down of the V-22 starting in 2020; we estimate that this program has historically accounted for around half of Bell’s operating profits.

In the second quarter, consolidated revenue increased 3.4% year over year to $3.7 billion. The industrial and Textron Aviation segments drove revenue higher, with the latter delivering 48 jets this quarter versus 46 last year. Turboprops saw a stronger increase in deliveries of 42% year over year, shipping 47 aircraft to customers this quarter, and we think international demand was an important driver. Aftermarket growth was also strong in aviation (a high-single-digit number, according to management). The smaller Textron Systems business saw revenue fall due to the discontinuation of the sensor fuzed weapon program this year. Operating margins at the segment level expanded 110 basis points year over year to 9.3% this quarter. Margins were up in each segment except for the industrial business, and similar to the first quarter, the aviation segment showed considerable margin expansion versus last year (up 350 basis points to 8.2%). Consolidated GAAP EPS from continuing operations came in at $0.87 this quarter compared with $0.57 last quarter, thanks to higher operating profit and a lower tax rate.