Ducommun Halts Descent

Over the past year, aerospace parts manufacturer DucommunIncorporated (NYSE: DCO  ) has been a quagmire for shareholders. Despite posting solid revenue growth and consistently landing major contracts with key players in the aerospace industry, sinking profit margins have caused the stock to stagnate. Indeed, Ducommun has been a cautionary example of the risks associated with investing in a company with a concentrated customer base.

These worrisome trends notwithstanding, Ducommun's third-quarter results indicate that the company may be charting a new course. Revenues grew more than 20% year over year. Interestingly, CEO Joseph Berenato indicated that recent sales growth is due in part to new (i.e., non-Boeing) commercial programs. This may be an early indication that Ducommun is diversifying its customer base.

Most importantly, profit margins, at 6.8% for the third quarter and 6.6% for the first nine months of 2005, are improving. That's well above the 2004 profit margin of 5%, and even above the five-year average of 6.2%, which is refreshing news for shareholders. Could the improved profit margin signal an inflection point of the company's operations?

There are several reasons why Ducommun's operations may be improving. Management has previously indicated that margins will increase as lower-margin startup programs evolve into higher-margin follow-on contracts. Thus, Ducommun may be reaching the higher-margin phase of some projects.

Furthermore, Ducommun has been implementing Six Sigma to optimize efficiency, which might explain some of the operational improvement. While these can be good conference-call talking points, sustained margin improvement truly results from a strong business model backed by efficient management. At the end of the day, Ducommun will be a lucrative investment if management can achieve reasonable growth in its profit margins to match the company's growing revenue.

While Ducommun lacks the operational consistency to be a Motley Fool Hidden Gems selection, the company is certainly hidden. The stock trades at an average daily volume of around 0.1% of the float, and the minuscule analyst following is evidenced by the lack of questions on the latest conference call. Being hidden is certainly an advantage to private investors, but to be a true diamond in the rough, Ducommun needs to prove that recent operational improvement represents a genuine point of inflection and not just an outlying point of a larger downward trend.

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Fool contributor Jason Mac Gurn owns shares of Ducommun. The Motley Fool has an ironclad disclosure policy.


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