In this episode of Industry Focus: Energy, Motley Fool contributor Lou Whiteman joins the show to break down earnings from Palantir Technologies (PLTR +0.10%), Virgin Galactic Holdings (SPCE +5.25%), and TransDigm Group (TDG 0.59%). In addition, Lou and Nick Sciple share their thoughts on the Colonial Pipeline shutdown.
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This video was recorded on May 13, 2021.
Nick Sciple: Welcome to Industry Focus, I am Nick Sciple. As earnings season continues to roll on, we've got some more reports to discuss this week. Lou Whiteman joins me to take a look at earnings from Palantir, Virgin Galactic, and TransDigm. Lou, thank you for joining me.
Lou Whiteman: Always a pleasure to be here.
Sciple: Great to have you back on the show, Lou. Before we get into the earnings reports, though, we have to talk about this gas pipeline situation in the U.S.A. for folks that haven't been following along. Colonial Pipeline, one of the largest pipeline in the United States, accounts for I believe the number is 45% of the gasoline that goes to the East Coast of the United States, was hit by a ransomware attack over the weekend by the Russian hackers group, DarkSide, which "compromised it's network." That has led the pipeline to be shut down since Friday. I believe we're starting to get back up and running this morning. The big headline this morning is that Colonial has paid the $5 million ransom to this DarkSide hacker group. What are your thoughts, Lou?
Whiteman: After Colonial said they weren't going to, apparently they already have because if the report is, we believe, they did it last week. The FBI doesn't want you doing this because this only encourages bad behavior. Maybe one good side about this, though, if you read the report, the decryption tools were so bad and they work so slow that Colonial ended up doing a manual backup anyway and getting its systems back on that way. So maybe this actually will encourage companies. They paid the $5 million last week and they still took the hit. Maybe that will encourage companies to act differently later, but yeah, crazy.
Sciple: One of the takeaways is that pipelines are important. We've talked about on this podcast in the past that there are certain pipelines in the United States, if you turn them off, all of a sudden the lights turn off or infrastructure stops working properly. We learned in the past week that this is one of those pipes. Pipelines are a really important part of our infrastructure and we shouldn't ignore that. The other thing is this ransomware thing isn't going to go away. You just mentioned, Lou, when you pay somebody $5 million, when they ask for $5 million, well, you know what? Maybe they're going to come back and ask for more. I think we can expect more of this, which makes cybersecurity that much more relevant. It's always going to be a challenge because the white-hat folks have to stay one step ahead of the black-hat folks. All these people are very competent in what they do. This is going to be a battle that's going to continue to play out I think for the rest of our lives.
Whiteman: Yeah, and it trickles down and it's only going to get worse. I always think about these things, like what seemed dangerous a few years ago seems quaint now. If you extrapolate that forward, then this will seem quaint in a few years and there will be much more scarier things out there. This is why I never sleep. [laughs] If you're bullish on the business story, yes, there's going to be plenty of demand for cyber and IT indefinitely in the future. We need the staff.
Sciple: On the topic of passing through massive amounts of data and intergovernmental intrigue on the data front, let's talk about Palantir. Folks who know about Palantir's role for a long time, working with U.S. intelligence agencies, they were behind catching Osama bin Laden a number of years ago. Now they are a public company and they just reported earnings. Lou, what do we know about the company today?
Whiteman: This is only, I believe, their second earnings report as a public company. They went out late last year. The headline numbers were all pretty good. They matched estimates of $0.04 per share of earnings. Revenue was a beat by about 3%. They guided higher, which you always want to see. They guided to, I think, $360 million of revenue in the second quarter, which is $15 million or so above the consensus. This is a company that is in growth mode. They see revenue growing at "at least" 30% a year through 2025. They're scoring wins. They do very, very complex stuff. Some of these government contractors just manage email systems. Palantir is in a different realm. They are data analytics, they're trying to bring this to the commercial side slowly and surely. But this is everything you'd want to see if you're a bull on this company because there's growth priced in here, and they're delivering growth.
Sciple: We can talk about the amount of growth that's priced in. The stock so far this year, year to date about 50% off its highs. You look at the price-to-sales ratio, it got as high as the 40s. Now it's down about 20 times price to sales, still very much pricing and continued massive growth. Like you just mentioned, this continued revenue growth of 30%. What do you make of the valuation in the context of the irons they have in the fire and the growth opportunities they see outside of their traditional government business?
Whiteman: Sure. If you want, I guess, the cracks in the story, I would say. For one, 30% annual growth by any standard is impressive. But it's worth noting in the last 12 months, they have grown at 47% year over year. That would be a slowing from where they are. This valuation, coming from the defense side, I can't put my head around it. Most of the comparables, and there is no real comparable here, but are trading at two times sales or less compared to 20 times sales. On the commercial side, Snowflake, people that you will see more on par valuation. It may be fair to at least say Palantir with its commercial business deserves to be above, say, Booz Allen Hamilton. But lost in the story in a way or you can't be lost, this is still very much a government-dependent business. If you look at the quarter, the government side is larger and it is growing faster. Government is 60% of total revenue today. It grew by 76% year over year on the government side. The commercial side is only growing at 19%. You are not going to transform yourself into a commercial-focused company if the smaller side is growing much smaller. I believe, and there's a history here, if they successfully grow out of the commercial, they will be a rare company. Many have tried. Commercial is a different animal, it's a different customer. You've already seen them partnering with IBM and other big names like that to try to sell this on the commercial side. That's good that they're doing that because it will broaden their exposure.
But at the same time that means you're giving IBM some of the margin and it sort of speaks to a weakness. You do not partner with these guys if you are really seeing the traction you hope for on your own. The other side of it, too, is this is high-end expensive stuff. This is the stuff that a company uses when they need to. It's not necessarily that we're going to take over all the IT budget. My fear here is that they need to grow into this valuation. I don't know if the market fully appreciates how difficult that is going to be or how much time it's going to take, so it's a hard moment. This is a great company, it's a great product, but even believing in the growth story, it's hard for me to wrap my head around this valuation.
Sciple: Just looking at historical comps, quite heavily valued. Is there a way you can get there? There's this idea that over time the way we engage in, I don't know what you guys want to call it, warfare or just intergovernmental conflict, moving more and more toward the digital space. Palantir, you could say, top dog and first mover as far as the type of work they do there. If we zoom out 10 years, do we see the addressable market just being that much bigger because of the trends we see in this space? Is the story you have to tell yourself as an investor?
Whiteman: You can. I think that's dangerous, because yes, Palantir can do things that nobody else can or that few can. But a couple of things on that, the government very much values redundancy. We've seen this throughout that the government will intentionally overspend to just keep two vendors in a field. I don't think there's a world in which Palantir gets 100% of the dark money or put between spy agencies. That's just not going to happen. Also for the size of this and for the amount that the government spends, this is a little over $1 billion company right now that's trying to get to $1.5 billion or so in the next five years. You're not going to see the Pentagon boosting this to a $3 billion or $4 billion company just on their spending alone. And again, with a market cap of $35 billion, there's expectations. The only way they're going to get there is on the commercial side. Again, they can. They have tools that I believe commercial customers will value. But will they pay up for it in the volumes that investors hope? That's a harder thing to imagine in a three- to five-year period. I'm not negative on the company, I've actually been watching very closely as the stock has come down. I don't know when I would get in, but I'm not opposed to owning this company. But I am just very cautious about valuation here. Just knowing the industry, knowing the defense side of the industry and how hard it is to grow when that customer is your primary customer.
Sciple: Absolutely. Just summing things up at 20 times sales still very much a show me story for Palantir and what we need them to show us is continued robust growth in the commercial business that it is able to justify that valuation or the valuation come down to price that's more reasonable to fit the expectations we can comfortably make. Moving on from Palantir, let's talk about another company, Virgin Galactic, that you could say is a little bit of a show-me story today as well. The company has had a rough few months. It's down 70% off its highs. What's going on?
Whiteman: Yeah, a rough few months for the stock, but honestly, a rough year-and-a-half now for the company. Virgin Galactic space tourism, they want to put you and I into space. You go first, Nick, [laughs] but that's certainly whatever you want. The goal was that they would begin service last year by launching Richard Branson into space for his 70th birthday. That was a big milestone, it was much talked about, obviously it didn't come to be. Now, COVID had something to do with that; it was harder to do tests, but they've also had a real tough time with their test. This is a company, the quarter was as bad or worse, we know this is actually a zero revenue company in the quarter. The analysts had hoped they would have about $300,000 in revenue basically, that was if they were going to do a test, there is going to be some small experiments on board that they would pay for. The loss of $0.55 per share was worse than expected. But again, I mean, they do have money in the bank, this is a work in progress.
The bigger issue is that they have had difficulty getting these tests done. Before it was a problem with electromagnetic feedback in the space capsule. They had set a self-imposed goal this month, May, to resume testing. On their earnings call they said that there is a new issue. There is stress and fatigue with the Eve. This is the plane, instead of just going up like a rocket, the way Virgin Galactic works is there is a massive plane that carries a spacecraft into low orbit where it launches from there. Which is a pretty neat way of doing this because it saves on a lot of the expense of that initial push off and fighting gravity at its worst [laughs] at the surface. But it's still very unproven because the Eve is so important to this. They're going to update us next week on when these tests might happen. Maybe they just need to get this figured out and moved on. They are planning a new plane to replace the Eve, but this is just issue after issue after issue. We're still hoping to begin service by the end of 2021, but with every delay you have to wonder about that and, yeah, the stock has traded down as a result. This is still a $4 billion company with no revenue and a lot of promise. I mean, this is, again, a very cool technology, but you've got to get there and you said show me. Right now, they're not giving the market's investors a lot of reason to trust their timetable and believe that it will go later this year, early next year as they hope.
Sciple: I think when Luis Sanchez and I, think when we first discussed the podcast prior to the IPO, a few months before the IPO and what I had said at that time is, it's a company I'm going to watch, I'm going to pay attention to, but it's not what I'm going to be interested in investing in until I see them take one customer on a safe trip up to space and back. It's because this is a really, really difficult thing to do, and if you model out some of the assumptions you have to make for Virgin Galactic, it comes out to putting as many people in space as like has ever been in space on a regular basis. To get from nobody doing it to putting enough people in space on a regular basis to make the business work is a lot of execution between now and there. The company still has a lot left to show us. What are you going to be paying attention to, is there anything else to watch other than waiting for the company to tell us they figured it out?
Whiteman: I think you make a great point because it's a show-me story times two. But yes, first you have to prove you have to do it but then also, this is a very, should we say niche market? [laughs] It is $250,000 to spend a few minutes weightless, it both sounds very cool, but it's not going to be a Coca-Cola business or something like that. I think what we're watching for right now is A, will these tests happen and will they go well, B, once they get going, what that market is, what the competitive position is, and all of that, and yeah, it's possible this will still work out. I think it's a cool thing to believe in and I think it's very binary though. It's also possible that space is hard and this just won't come together or it will come together after a lot of other people figured it out. No one can say for sure, not even inside Virgin Galactic headquarters right now can they say for sure. The big thing is, we need tests to go well and then from there we'll figure out the business and figure out their prospects.
Sciple: We'll see, I'm fairly confident at some point in the future that there will be people going to space for fun who aren't professionals or hired by the government or what have you. Who the companies will be taking those folks and how soon it will happen, I don't have the faintest idea, but when we do, we'll be on the podcast and we'll talk about it.
Whiteman: Right. [laughs]
Sciple: Let's move on to the last company we're going to discuss today, that's TransDigm. TransDigm is, if folks aren't familiar with the company, one of the largest manufacturers of airplane component parts. Were impacted by the pandemic, air travel cut back last year, what's going on with the company today?
Whiteman: People who were listening before know this is one of my favorite companies to talk about. It's a company that has both been a great performer, but there's also been a lot of criticism attached to it. The great thing about this last year is that I think a lot of the criticism, we had a trial under fire, and the company has come out real well. This is a company, as you say, they make mostly spare parts for commercial airplanes. That is their bread and butter business. They reported a quarter of $2.58 per share on revenue of $1.19 billion that beat estimates by 3%, 2%. Organic revenue was down 20% year-over-year, that is the COVID effect. But even with commercial organic down 43%, the aftermarket which is spare parts down 39%, this is a company that still managed an EBITDA margin of 43.5%. You don't see 40% margins in most manufacturing businesses, especially most component-part businesses. TransDigm, the ticker is TDG, this is a stock that has grown by 1,000% in the last decade or so. I don't have the rough numbers in my head. But forever the criticism has been these margins aren't sustainable. But what we've seen now is through the worst aviation crisis in global industry history. The margins were sustainable and in fact they held up better than the company thought.
They have a lot of variable parts of costs, they have parts that are very, very important and it really seems like now the worst is behind us. Aftermarket demand was up 14% on a sequential quarter from fourth-quarter 2020, orders were up 30%. There's some concern that I have that maybe this is just restocking supplies, it's going to be like, think about it, now that airlines are flying again, they want to build back up their supplies. Management says this is sustainable, it's not just stockpiling, it's something we're going to watch but I take them at their word. This is a company that is proving its need to the system in a very, very difficult operating environment. Everything I loved about TransDigm before, I love it more now. I think [laughs] coming off of this and just seeing how they've gotten through this last year.
Sciple: I think one other thing to mention, folks talk about TransDigm is a very levered business model and the fact that they were able to roll through the pandemic without that leverage biting them, I think says something as well. Now, we can say that the Federal Reserve helped out lots of highly levered companies for whatever reason, that risk did materialize in the way many folks may have expected.
Whiteman: Yeah, and it's funny because it's a great point to make and it's something that they are addressing. As a bull, I'm almost a little disappointed here but I certainly understand it. This is a company, they don't pay a regular dividend, but they're always on the lookout for acquisition. You can think of this as almost as a private equity firm, disguised as an operating company. They buy good businesses, they clean it up and leave it alone. They prioritize cash for acquisitions, but they have a history of doing very, very rich $35, $40, $50 a share, special dividends almost on an annual basis recently. A couple of years, they've done two of those. We're not going to see that. For now, special dividends, buyback, they're putting that on hold. They want to recharge their balance sheet, net debt is currently about eight times EBITDA, which is a little on the high side for them but they have done some deals. But they think it's going to be a buyer's market in the next 18 to 24 months and they want to be ready for that. This is a trust the jockey story because it's such a collection of parts, so I respect that, I like it when they buy, but I have been thinking with the way cash was piling up, that we were going to see a nice maybe even toward a $100 a share dividend sometime later in the second half of this year. Apparently I was wrong to hope for that, that's not happening. So that's a good and a bad, but it does change my thinking I guess from coming into the quarter.
Sciple: We'll see what they do with that cash. Obviously, they were impacted by the pandemic. You could tell a story for an acquisitive company. We've got the capital gains tax going up. Maybe there are some deals that are going to come to market that would've been there otherwise. Maybe the last thing on TransDigm, you mentioned these margins which are remarkably high, especially when you think about it. This is used parts and companies try to make generic parts and things like that. Why do you think TransDigm has surprised folks and been able to maintain such high margins for so long?
Whiteman: The analogy I'd use is the analogy of what we try to do with stocks. You pick the best companies and then you get the out-sized returns. TransDigm is very good at finding that rare spare part. What they're looking for is a business that makes parts that are in desperate need. You can't fly the plane if you don't get this part, but aren't high volume. There isn't really the business case for someone to commoditize it or cut it in or set up their own factory. They also have a lot of patented parts. It's that sweet spot of parts for these airplane platforms that are both necessary but aren't high-volume. They're not going to make napkins or something like that or a consumable. That is their formula. They haven't always gotten it right, but they are also pretty good. They bought a huge business out of the United Kingdom last year. They sold off about half of it because they only wanted some of the parts in there. They are very picky about what they buy. Patent protections help.
You always see their margins get thrown up against them, because they do have a defense business. There was a short attack on them a few years ago that basically said, "This company that sells to the Pentagon is getting 40% margins." If you break it down, they do have a lot of defense businesses, but most of those are 5 to 10% cost plus things. They have a proven track record with these airlines that we can get you a part overnight that otherwise you would have to ground this plane and leave your revenue. They have these relationships, they have these parts that you can't easily replicate. Yeah, I mean, maybe the model won't work forever, but we're going on a decade-plus now of it working just fine. I don't see any real reason to think that's going to go away.
Sciple: Yeah. I've heard a description of that. You shouldn't think of it as a product business as much as a service business and the service says we have a supply of these super niche products available for you at all times. Whereas the product itself, maybe you're not willing to pay a 40% margin on it. You are willing to pay that margin to have the product tomorrow so you don't lose revenue for grounded planes and all those sorts of things. Yeah, there are these interesting companies where they're a product company where there's a service hidden inside of it that you don't really necessarily notice unless you understand the nature of the business and all those things.
Whiteman: If there's one bit of caution, I will say some of these parts, airplanes are becoming much more commoditized. Boeing and Airbus are getting a lot better at these things. A lot of the best parts are on planes that have been around for a long time. Some of those planes are the ones that have gotten retired because of the pandemic. There was a fear. I think that will cost them some of their potential growth in the years to come if some of these older air frames have a shorter than expected lifestyle, it's still debatable. A lot of those planes will end up in developing markets even if they're not being used in the United States. But yeah, I mean, it's also a very hard business to replicate for that reason though, too. You aren't seeing a lot of parts on the 737-MAX that have quite the attractive profile as some of the parts on say a 20-year-old 737.
Sciple: Last thing on TransDigm, you mentioned it's one of your favorite stocks. Still on that list of your favorite companies?
Whiteman: Absolutely. You were talking with Jim Gillies yesterday about I think he said a test stock that he would just put away and not look at for 10 years. It's scary to say that with an aerospace stock. I started thinking about why I would say that and TransDigm did come to mind. I'm going to own this company indefinitely. That's my plan with it.
Sciple: There you go, folks. Lou has spoken on TransDigm. Before we wrap everything up, I just wanted to talk just briefly about the market. We mentioned Palantir down significantly, Virgin Galactic down a lot from the highs. You're seeing the markets in turmoil, specials on CNBC and all across. What advice do you have for folks who are managing their portfolio during all of this volatility right now?
Whiteman: I hate giving this advice because it's hard, it's almost impossible. You know, the first thing is don't manage right now. Try not to. Believe in yourself that you've picked good companies and try not to look at the daily headlines. I know that's easier said than done. But also the second thing is diversity. Diversification, this is why it works. I mean, TransDigm, they are down slightly for the week but they were basically flat. They were up. Of these three, if this was a basket of these three we would've been down, but we wouldn't have been down so much because we had an aerospace parts manufacturer. I have a lot of software-as-a-service stocks. I have a lot of different stocks, but I do think whether you call it a return of value, there are overtime market shifts and this is the value of having at least some exposure to different parts of the market. Just believe in yourself, believe in the process, and try not to get caught up on the day-to-day. It's really hard to do, but it does work.
Sciple: Yeah. Totally agree with that. My advice would be, when we talked about these earnings reports today, think about the ratio of time we spent talking about the stock price and how much time we spent talking about what these companies are actually doing, I think when you're thinking about volatility, thinking about your portfolio, thinking that the companies that I own, pay attention to the things happening in the real world, actually going on with these businesses. Those are the things. Those facts are predictive about where the company is going to be in the future. Not this week's volatility or even this year's volatility. Whether or not the market is up or down this week, if Virgin Galactic can't figure out how to get their customers into space, the stock isn't going to perform well. These are the types of things that we should be paying attention to because those are the things that are going to drive returns over the long term.
It's a lot easier to focus on those things if up front when you picked the stocks you did research and you understood the reasons that you held it and can check back against that thesis going forward. I think this volatility where it gets really hard and really dangerous is when you don't know what you own because then you don't know whether you're wrong or whether there is just volatility going on in the market. Big advice, too, is just always know what you own and pay attention to what's going on in the real world. If you do that, I think it's a whole lot easier to hold through all this craziness.
Whiteman: Yeah. What he said.
Sciple: Yeah. Lou, always great having you on the show.
Whiteman: Always a pleasure to be here, Nick.
Sciple: As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for mixing the show, for Lou Whiteman, I'm Nick Sciple. Thanks for listening and Fool on!
