The recent sell-off in advanced composites company Hexcel (HXL -0.31%) is a buying opportunity in a compelling long-term growth story. The company is set for solid growth in the coming years, and investors shouldn't fret too much over its near-term free cash flow (FCF) outlook. Here's why Hexcel is a great candidate for a growth investor's portfolio.
The investment case
First, a few words on what makes the stock attractive. The case for buying Hexcel rests on the idea that sales in its core market, commercial aerospace, will grow enormously as Boeing and Airbus ramp up airplane production rates. Moreover, the company's composites offer a weight and strength advantage over traditional metals and are increasingly used on newer models. Hexcel's composites are also used on larger business jets manufactured by Dassault and Gulfstream.
As such, Hexcel's revenue will grow even if the same volume of airplanes are produced -- provided a higher percentage of newer models are built. Hexcel also has a growth opportunity from the return of international travel because that usually leads to an increase in widebody orders and production. Hexcel has a higher amount of content per airplane on widebody models, where managing weight is an even more significant issue than on narrowbody aircraft.
All told, it's a long-term growth story driven by a combination of a ramp in airplane production and an increase in Hexcel's content per plane.
Hexcel's third-quarter earnings
The themes discussed above reflect in the recent third-quarter result shown below, where you can see a strong increase in commercial aerospace revenue driven by "growth in the Airbus A350 and A320 NEO programs," according to CEO Nick Stanage on the earnings call.
First Nine Months Sales
Year Over Year Growth
Space & Defense
Wall Street analysts believe commercial aerospace will drive low-teens percentage revenue growth in 2023 and 2024, with profit margins growing as volume increases.
What the market is worrying about
While the medium and long-term outlook remains excellent, the stock sold off after the results, not least because management cut its full-year FCF guidance while not significantly increasing its full-year revenue and earnings guidance. Management did hike the midpoint of its revenue and earnings ranges, but FCF guidance was substantially reduced.
- Full-year sales are now estimated to be between $1.53 billion and $1.6 billion, compared to the prior estimate of $1.5 billion to $1.63 billion.
- Full-year adjusted earnings per share (adjusted EPS) estimates are in the range of $1.12-$1.24, compared to a prior estimate of $1.0-$1.24.
- Free cash flow is expected to clock out at $100 million, compared to a prior estimate of more than $145 million -- capital expenditures still forecast at $75 million.
That said, it's important to understand why. It wasn't because of increased capital expenditure requirements. Instead, CFO Patrick Winterlich put it down to "primarily due to higher raw material inventory levels as we purposefully increase our safety stock."
In a nutshell, Hexcel is suffering from the ongoing and well-documented supply chain issues hitting the aerospace industry, something the market has already factored into its stock price. In addition, it's an issue impacting manufacturers across the supply chain as the economy continues to recover from the COVID-19 lockdowns.
As such, management is using cash to buy and build inventory to avoid production disruptions caused by delays in getting hold of materials and components. It's definitely not an issue of slowing demand; on the contrary, Stanage noted, "We actually have stronger demand than we produce...in the third quarter."
As long as end demand remains strong, the inventory will be utilized with Hexcel generating more earnings cash. On that note, Boeing and Airbus continue to try and find ways to ramp up production even as they grapple with supply chain availability, particularly with engines.
A stock to buy
Taking a longer-term view, everything points to increased FCF generation, not less, even if Hexcel is going to take a near-term hit as it prepares for growth by building inventory. As such, the dip in the share price is a decent buying opportunity in a stock with plenty of long-term growth prospects.