Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Profitable and growing earnings at a double-digit rate, plane-parts maker Curtiss-Wright (NYSE:CW) isn't the kind of stock you'd expect to be down 15% over the past 12 months. But thanks to investors' decision to sell off aerospace and industrial stocks over the past couple of months, Curtiss-Wright shares are down 15% this year, and down 26% from their September peak to boot.
Investment banker Stifel Nicolaus thinks this marks an opportunity to buy Curtiss-Wright stock at a discount, and upgraded it to buy this morning, with a $122 price target.
Here's what you need to know.
It's been more than a year since we last wrote about Curtiss-Wright here at The Motley Fool, so a brief reintroduction to the company may be in order.
When you hear the name "Curtiss-Wright," you probably think "airplanes" -- and that's only logical. During World War II, for example, Curtiss-Wright was America's second-largest defense contractor, and a major producer of fighter planes used in all theaters of the war. But over the years, Curtiss' importance to the aerospace industry has diminished, while its importance to the Navy has increased. Today, the company divides its business among three main lines:
- Defense produces computing modules and other electronics for the Navy and other military branches, and provides roughly 25% of Curtiss' $2.3 billion in annual sales.
- Power accounts for another quarter of the company's revenue from the sale of pumps, motors, and generators.
- And commercial/industrial, the flagship business, provides the other 50% of Curtiss-Wright's revenue from the sale of highly engineered products and services such as electronic and electro-mechanical control units used in the aviation industry.
Of the three, defense is still the company's most lucrative business, producing enviably rich operating profit margins of 19.5%. (S&P Global Market Intelligence data show that Curtiss' overall operating profit margin is 15%.)
Why Stifel likes Curtiss-Wright stock
The U.S. Navy -- specifically, the submarine force -- is arguably as important a customer for Curtiss as the U.S. Air Force was way back when, and the profit margins it's helping the company to generate have to be the envy of the defense industry. Rival naval contractors Huntington Ingalls and General Dynamics, for example, have to get by on operating profit margins of just 11.6% and 13.5%, respectively.
And yet, it's not profits -- or at least, not only profits -- that attract Stifel Nicolaus to Curtiss-Wright stock today. Stifel sees the company growing its profits as the defense budget grows, yes. But Stifel also predicts investors will adopt more generally "defensive ... positioning" as the economy sails toward a potential recession in 2019.
In this scenario, argues Stifel in a note covered on TheFly.com, the analyst is even more interested in finding companies with "strong balance sheets to both protect and provide flexibility to pick off quality assets should a downturn materialize." And as Stifel explains, Curtiss-Wright boasts a "[v]ery strong balance sheet," with only about $568 million in long-term debt, and a "net debt to trailing EBITDA forecast at a low 0.8x," as reported by StreetInsider.com (subscription required).
Valuing Curtiss-Wright stock
To put that debt load in context, Curtiss-Wright generated positive free cash flow of $277 million over the past year. At that rate of cash production, the company could pay off its debt, and become net-debt free, in just a little over two years.
And $277 million is also about 6% more cash profit than the $261 million in net income that Curtiss has reported over the last 12 months, indicating a very high quality of earnings at the company. Valued on its free cash flow, Curtiss-Wright sells for only about a 16.4 times FCF -- cheaper than the valuations at either General Dynamics (20 times FCF) or Huntington Ingalls (33.4 times FCF).
With a 13.4% projected long-term earnings growth rate and a token 0.6% dividend yield, Curtiss-Wright's expected total return over the next five years should be about 14%, annualized. That doesn't make the stock cheap, exactly. But given the alternatives in the defense industry, I agree with Stifel Nicolaus: Curtiss-Wright is at least a relative bargain in defense, and a viable defensive investment if we're heading into a recession.