Textron (TXT 1.74%) delivered a disappointing third-quarter report, missing earnings estimates by $0.15 on revenue of $3.2 billion down 8% from a year prior and below expectations. Shareholders acted accordingly, sending Textron shares down about 11% the day of the announcement.
The results were a significant setback for Textron, a somewhat quirky industrial conglomerate that makes everything from snowmobiles to military helicopters, and from golf carts to business jets. However, investors running for the sidelines are underestimating the potential for some of the company's stronger businesses.
Artist rendering of a Textron-made Bell V-280 in action. Image source: Textron.
The stock, thanks to the post-earnings sell-off, is more affordable than it was just 10 days ago. Here's a look at what went wrong during the recently completed quarter, and what the outlook is for the company heading into 2019.
What happened?
The big loser in the quarter was Textron's industrial segment, maker of E-Z-Go golf carts, Jacobsen turf maintenance equipment, off-road vehicles, and tow tractors used at airports, among other products. Industrial experienced weaker-than-expected sales and higher rebate reserves in part, according to CEO Scott Donnelly, due to issues at the Arctic Cat brand acquired by Textron in 2017.
Donnelly, on a conference call with investors following earnings, said the company needs "to work on our go-to-market strategy" for industrial "and focus on cost performance," admitting the issues have affected the entire industrial unit:
When you have something like that going on in the business, it creates enough chaos that it drives down the operating performance in total. Most of that -- I think we have a very good team in place. They've done a great job in the past and I think they'll recover, and the performance and profitability of most of those subsegments -- if you will -- will do just fine. The area that is going to require the most work and the most focus going forward is around that acquired piece of the business.
Elsewhere, there was more of a mixed picture. Aviation volume declined, but margins increased year over year on a better product mix, and the unit's book-to-bill soared to 1.21 times thanks in part to renewed interest in business jets. Meanwhile, Bell, the legendary helicopter-maker behind the Army Huey, saw profits improve, but revenue decline on an improved mix, ending the quarter with a backlog worth $5.7 billion.
Looking to the skies for help
That improved aviation book-to-bill should only get better in the quarters to come. Business jet sales have been in a slump since the 2008-2009 recession, but a combination of an aging corporate fleet, biz-jet-friendly changes to the tax code in terms of how depreciation is calculated, and a strong business environment has the industry poised for an upswing.
Textron has a product refresh arriving just in time for a potential order surge, with its new Citation Longitude on track for certification by the end of November and deliveries to follow soon after. Earlier this month, after the quarter closed, Textron announced a deal with Berkshire Hathaway-owned NetJets to buy up to 325 Cessna Citation jets.
The company believes it can achieve 20%-plus operating margins on the Longitude once it hits full production. If so, that division should generate enough earnings power and free cash flow to offset any industrial issues that linger into 2019.
Military strength
Textron is also one of the likely beneficiaries of a move inside the Pentagon to revamp the U.S. Army away from fighting insurgencies and toward countering a major-power adversary like China or Russia. That transformation is going to force Army planners to make difficult procurement decisions in the years to come, which could help Textron in some upcoming competitions.
One of the tough choices the Army is predicted to make would be to shift future spending away from its core Apache, Chinook, and Black Hawk helicopter programs and toward new, more versatile technologies. Bell's V-280 Valor tiltrotor aircraft has been under development for more than five years, and it's seen as a favorite to be chosen to replace the Black Hawk as the troop transport of the future. The company also has viable candidates for future reconnaissance and long-range attack aircraft.
In addition to the Bell designs, Textron also has other aircraft involved in ongoing military competitions.
Just winning the troop carrier would set Textron up nicely, as the Army could order as many as 3,000 units at more than $20 million apiece over the lifetime of the program. The impact to earnings will not be immediate, because even if the Army was to decide to place an order for the V-280 tomorrow, there will still be a substantial low-margin development and ramp-up period. But the outlook for future military orders could significantly alter Textron's earnings potential over the next half-decade and make the overall company more resilient in the event of future hiccups elsewhere.
Textron is a long-term buy
The third-quarter earnings surprise erased what had been shaping up as a strong year for Textron, with shares up more than 24% year to date thanks to growing optimism about the business jet unit prior to the recent fall.
TXT year-to-date data by YCharts.
The quarterly results were certainly a disappointment, but I believe the excitement about a business jet rebound heading into 2019 is justified, and as programs like the V-280 mature, Textron's long-term visibility will improve. The company, thanks to the recent decline, now trades at a discount to most defense contractors in terms of forward price-to-earnings and as a multiple to future projected EBITDA.
The third quarter turned back the clock and gave investors a chance to buy into Textron at 2017 prices. The near-term outlook remains a bit choppy, but for long-term investors, now is a great time to buy into Textron.
