Precision Castparts Pleases Investors

Precision Castparts (PCP.DL) missed analyst estimates for revenue and EPS in its first-quarter results, yet the stock moved sharply higher on the day. The company has disappointed investors with its past few earnings reports, but that wasn't enough to stop Warren Buffett's Berkshire Hathaway from adding to its position in the stock. Despite the disappointments, or possibly because of them, the stock has become a value proposition. Let's look at what happened in its first quarter.

Q1 review
The results didn't look good on a superficial basis. For example, sales declined 4% in the quarter, with operating income down 16% against the same quarter last year. However, according to CEO Mark Donegan on the earnings release, management left its "view on our core operations and end markets" for the year unchanged. Investors must have breathed a sigh of relief with the maintenance of its core guidance, because it comes after a few disappointing quarters.

The company missed estimates in its third-quarter results issued in January. Furthermore, the fourth-quarter results in May were mixed, with the company seeing weakness in oil and gas spending, as well as ongoing destocking from a major aerospace customer -- with most of the impacts being felt in the Forged Products segment.

A look at full-year guidance:

• Sales of $10 billion to $10.4 billion compared with analyst estimates of $10.2 billion.
• EPS from continuing operations fell in the range of $12.25 to $13.15, compared with analyst estimates of $12.77
• The free-cash-flow range falls in a range of $1.4 billion to $1.5 billion

A deeper look at results
A look at segmental revenue reveals that the Forged Products segment is still suffering the effects of falling oil and gas sales. Forged Products sales declined 8%, but excluding the negative impact of metal pricing, currency movements, oil and gas, and other non-industrial gas turbine markets, sales were up 3%. Furthermore, commercial aerospace sales in the segment rose 5% in the quarter -- including the ongoing effects of a large aerospace customer that's continuing to destock.

Source: Precision Castparts presentations; 100 basis points = 1%.

The Investment Cast Products segment saw a similar dynamic, whereby commercial aerospace sales increased 6%, while regional and business jet sales were described as stable -- somewhat disappointing, given that they're usually seen as harbingers of a cyclical pickup. Meanwhile, military shipments were 15% lower.

Turning to Airframe Products, the news was mixed. As ever with Precision Castparts earnings, there were some surprises in its production plans. In truth, it's hard to find a heavy engineering company that consistently produces in line with its previous announced plans. Although overall headline guidance was largely unchanged, Donegan outlined some production adjustments with Airframe Products: "We believe Airframe Products revenue growth is more likely to be at the lower end of our previously discussed range, reflecting the effort to balance the new development work with ongoing production."

In fact, the margin decline of 200 basis points in the segment was put down to a "mix of lower volumes, product mix, and initial efficiencies on new product introductions." No one said heavy engineering was always going to flow smoothly. Moreover, commercial aerospace sales in the segment were "relatively flat year over year, reflecting fastener demand timing and impact of new development work on aerostructures sales."

The takeaway
All told, it was yet another mixed report from Precision Castparts, but at least the company didn't cut guidance, and that was obviously enough to encourage investors. Its core aerospace operations look in good shape, but the inevitable production and demand lumpiness that nearly always accompanies production in the aerospace industry are apparent in the results. Oil and gas continues to act as a drag on results. But no matter -- the company appears to be stabilizing, and its long-term prospects in aerospace look positive.