PCP: The Best Aero Play

One look at PCP's chart over the last three years and you have to wonder "how high can this go?", but when you look at what they have done with their cash you still want to stay long this year. PCP has made some very timely and helpful acquisitions that have immediately been accredited to earnings and helped to "fill out" its portfolio of offerings (such as fasteners).


I think PCP is still a buy. I first bought PCP when the stock was in the low $70’s (average cost basis of $74.00) and am still long PCP and trade call options. I bought PCP for the following reasons:

• Management seemed very solid, knowledgeable about their business, and has a recent track record of under promising and beating expectations. Their divestitures and acquisitions seem on target and they seem to have a track record of successful integrations. The stock options are not ALL sold (they keep at least some) – This is fairly common with financial advisors counseling diversification of wealth.
• The Experts like it. Veterans on the TIE Investor Village Message Board (Supperust and Raybans) had endorsed it. This caused me to take a look. With Scupper’s 27 years in the metals industry, I felt that I would have someone who could spot problems, if any arise. Investor’s Business Daily also heavily endorses this stock.
• The Aerospace Cycle seems to catch PCP later in the cycle than the titanium companies I follow like TIE and ATI. For TIE and ATI, their run will end shortly (at least in the next two years) while PCP still will see a lot more upside through 2012. This cycle is huge and longer than previous cycles and the company describes their business as “robust”.
• Diversification is both a weakness and a strength with PCP. While they are highly leveraged to the Aerospace market, they showed that they can still maintain profitability even during a downturn (2002) They are working hard to diversify into industrial and power generation to offset any future slowdown in aerospace through niche acquisitions and organic growth.
• Repeat Business is a strength. Their major clients (GE, P&W, and RR) have been clients for decades and the relation is not hostile like the titanium business.
• They Pass on Raw Materials Costs - well they do kind of. They have put escalation clauses into their contracts, but sometimes have to absorb the increased costs. However, if the costs of raw materials eventually declines (we think it will), then PCP can marginally benefit.
• Impressive Financials with a PEG of 1.01, EPS estimates that have been revised upwards significantly all year, analysts that like the stock, a history of beating estimates, an operating cash flow of $500 million, a small dividend, and an ROE of 22%.
• Good Ownership Stability with institutions owning 86% of the stock that includes big names such as Fidelity and Janus, a short interest of only 2% of the float, a beta of 1.47 (enough to keep us options traders interested), a history of stock splits (last in 2005), and a 68% increase in stock price over the last 12 months.

Revenue in 2006 has increased by 21% from 2005 from $2.92 billion to $3.55 billion. Sales within the aerospace market area increased by 30% and Power Generation sales increased by 26% driving overall revenue increases for the company.

The Cost of Goods Sold represents approximately 77% of revenue down from 78% of revenue in 2005. Greater efficiency and economy of scale drove down costs but this was partially offset by increased raw materials costs and lower sales prices in certain areas due to competition.

SG&A represents 7% of revenue, down from 8% of revenue from 2005 due to increased sales volumes.

Net income from continuing operations for fiscal 2006 was $349.1 million, or $2.57 per share (diluted), which included restructuring and asset impairment charges totaling $0.02 per share (diluted). By comparison, net income from continuing operations for fiscal 2005 was $239.5 million, or $1.80 per share (diluted), which included restructuring and impairment charges totaling $0.01 per share (diluted). Fiscal 2006 net income after discontinued operations was $350.6 million, or $2.58 per share (diluted), compared with a net loss of $1.7 million, or $0.01 per share (diluted) in fiscal 2005. The fiscal 2005 net loss includes charges totaling $248.0 million, or $1.86 per share (diluted), related to the Company’s decision to sell the pumps and valves businesses. It should be noted that PCP has made a number of acquisitions from 2004 to the present that have been additive to earnings. They have also sold businesses within this timeframe to focus their efforts on their core operations.

In terms of Company Outlook, PCP expects that the aerospace and power generation markets will continue to strengthen through fiscal 2007 as commercial aircraft build-rates and large-frame OEM industrial gas turbine deliveries increase. The momentum in aftermarket demand and market share gains is also expected to continue.

With the acquisition of SMC, PCP expects some shift in its product mix, with approximately 54 percent of sales going to the aerospace market (versus 59 percent last year) and approximately 23 percent of sales going to general industrial markets (versus 15 percent last year). PCP’s base general industrial markets are also expected to grow due to increases in non-aerospace military programs such as the howitzer armament program and other land and marine-based ordnance programs.

Overall, base business sales are expected to approximate market growth for the aerospace, power generation and automotive markets, and approximate GDP for other markets. The acquisition of SMC is expected to increase fiscal 2007 sales by more than 25 percent over fiscal 2006 levels.

Operating earnings are expected to benefit from the sales volume increases from the base businesses, continued operating improvements, and 10 months of sales from SMC. Operating margins of the Company’s base business, as a percent of sales, is also expected to show improvement over fiscal 2006 levels principally due to leverage from higher sales volume and improved operating performance, partially offset by the dilutive impact of increased material pass-through pricing and the impact of expensing stock options. Operating margins will also be diluted by the addition of SMC, which has lower operating margins than the Company’s base business.

I own PCP stock and calls.