A Breakdown of Hexcel Corporation's Q3 Earnings Results

Aerospace investors were eagerly awaiting Hexcel Corporation's (HXL 1.62%) financial results for the third quarter, which it reported on Oct. 18. Like many other stocks operating in the aerospace industry, Hexcel has faced some tremendous hurdles during the pandemic and its balance sheet still hasn't fully recovered.

But, it appears that the company may be turning a corner as the world slowly adjusts to the post-pandemic normal and travel resumes globally. In this segment of Backstage Pass, recorded on Oct. 19, Fool contributors Lou Whiteman and Brian Withers do a deep dive into the company's third-quarter earnings report. 

Lou Whitman: Earnings per share as you see $0.05 beat, however, revenue was a pretty substantial miss. This is something that's been going on, I put the stock chart up there. This has not been a great performer versus the S&P 500.

You can see they were hit harder than the market average when COVID hit, and it has been a slow comeback. A couple of things that I took from this that I think in terms of where they are right now, destocking. This remains a four-letter word in the aerospace business.

Think about it this way. Boeing and Airbus at normal times keep a steady stream of parts components coming into the factories. If production is disrupted, the store of components builds up. In response, Boeing and Airbus will buy smaller quantities while they work through their inventory.

That's been going on for about a year now. This process of paring down your inventory, getting back to normal orders is called destocking. It continues to eat into the results of Hexcel and a lot of these other companies that rely on OEMs, new plane manufacturers. 

Management had pretty good news on that. They think the destocking story is "largely behind us," and hopefully so because we need to normalize. I will talk about how easy it's going to be for them to normalize in a second.

Another piece of good news is, we've seen a lot of commodity prices spike, they are not worried about raw material inflation right now. Hexcel says, at least for now, they do not think they need to change how they are thinking about the world. They did not see it affect them in this latest quarter, they have long-term supply contracts, they use commodity hedging.

For now, they think they can get by without what they called noticeable cost inflation. We hope so because they have a lot going up against [inaudible 03:08:48] ones right now even without that, so they're going to need that. The beat was fueled by largely margin. As you can see, the earnings were better on worse-than-expected revenue, their margin was up 110 basis points for the second quarter.

We're still not normalized yet, but we are at least working toward normal, which is I think the best we can hope for. A few things still to watch, the 787 as I said, is a big part of their business, this program is a mess. Boeing is having a lot of problems in part because of the carbon fiber.

It's not really a Hexcel problem, but they had seams that they are seeing that maybe in their design they did not make them as strong as they should've. Boeing is in a pretty low rate, couple that with destocking, it's hard to say when Hexcel's most important program will be up and running again, so that's a real concern. 

They have not given guidance since COVID began, they are still not giving guidance, the dividend remains suspended. Thanks to a one billion revolver they took out last year to make sure they get through COVID, they are restricted in their share repurchasing. We're still in limbo, and this is not a cheap stock relative to some aerospace companies, even with what you see with that stock chart.

I don't know what to say, it still looks like the worst is behind us, but we're still not back to where we should be. There is a lot of potential here, this is the future in terms of how manufacturing's going to be done, not just in aerospace and a lot of different ways, but we're in a weird period right now. This is very much a find a trend and get in early and not a proven winner right now.

Brian Withers: Yeah, Lou. I think that was as a great update. This is one of those companies where for now I would think for the next couple of quarters you watch these guys really closely and see when the stuff is going to turn around. Did you say a majority of their revenue comes from Boeing and Airbus?

Whiteman: Yeah, a majority is aerospace. When we look at aerospace, we break it down, especially on the supplier side into two areas: the OEMs and what we call the the aftermarket, or the spare parts for existing planes. As you can imagine, aftermarket has done a lot better and it's come back a lot quicker.

The airlines took on $50 billion or something in the U.S. just alone to get through last year. They are not a great position to take delivery on new planes right now. What they need to do is work their existing fleets harder. We have seen spare parts companies. I'd like to talk about TransDigm, Heico that are in our universe, have come back a lot faster.

Hexcel really needs the OEMs. This is a market that is totally in new plane fabrication. To some extent, they need Boeing and Airbus to be flying high again, and I do think that's going to be probably a second half of the decade story before we really begin so-

Withers: [laughs] Not even the second half of the year, second half of the decade.

Whiteman: No. I mean, I really believe that. I mean, we had a huge up-cycle before then, so it's going to take time. That's why I think the other business, the composites for wind turbines, moving deeper into automotive, there's a lot of uses for this, and I can't emphasize enough, this is a very hard chemistry to get right, and it's very capital-intensive to set up these factories.

There are some moats, there's a lot to like about this for a very long-term holder, but there isn't a lot to say for the next quarter or two. 

Withers: Right now. Well, Lou, that was a great introduction to a really interesting technology company. Thank you.