For four straight quarters, Textron (NYSE:TXT) has been turning in earnings numbers that not only beat their previous years' results but trounced analyst expectations to boot. When the defense contractor reports Q3 2006 earnings Thursday morning, investors will be looking for more of the same. Will they be happy?

What analysts say:

  • Buy, sell, or waffle? Thirteen analysts chart Textron's flight path (as noted above, usually unsuccessfully). They give the stock 11 buy ratings and a pair of holds.
  • Revenues. On average, the analysts estimate that Textron's sales fell 6% compared to the same quarter last year, to $2.7 billion -- the same as it achieved in Q2.
  • Earnings. But they predict that profits rose 16% to $1.24 per share.

What management says:
According to CEO Lewis Campbell, "strong growth and performance at Cessna and Textron Financial" plus "substantial progress" at Bell Helicopter and "improvement" in the Industrial segment all added up to just "solid" results last quarter. If that sentiment seems a bit underwhelming to you, then be aware that he has traditionally been sparing in his praise of this company's results. Speaking of which, don't expect him to wax enthusiastic anytime soon. According to Campbell: "We see continued strength in most of our end markets through the rest of this year and decade" [emphasis added].

In other news, in August, Textron sold its fastening systems business to private equity firm Platinum Equity for a "cash payment of $610.2 million, assumption of $15.1 million of net indebtedness and assumption of certain liabilities." Expect this to provide a welcome one-time boost to earnings in Thursday's news, but to barely move the needle on the firm's mammoth $8 billion debt load.

What management does:
Margin trends at Textron continue to be plagued by so-called "one-time" charges. Starting from the top, rolling gross margins are suffering, as cost of goods and services keep rising faster than sales. (Sales have been up 10% on average over the last six months, while COGS has risen 15%.) Operating margins are on the uptrend as management counters raw material price increases by tightening its operations; within the same period, operating costs rose just 9%. As for the net margin, well, we warned you about that three months ago. The October and December $300 million-plus charges to earnings continue to weigh on the rolling net, and the firm added another $108 million charge from discontinued operations last quarter.

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All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
So the rules of GAAP accounting continue to weigh heavily on Textron's net profit, but what about free cash flow? Knowing the value of this metric, Campbell makes a point of emphasizing free cash flow production at his company every quarter, and continues to predict $550 million to $600 million worth of the green stuff by fiscal year-end. So far, he's hitting all his targets, so let's assume for the sake of argument that Textron maxes out its projections and generates a full $600 million this year -- does that make the stock a buy?

In this Fool's view, no, it doesn't, and for two reasons. First, $600 million in free cash flow is less than the firm's $649 million in trailing GAAP net profit -- I'm usually leery of companies whose GAAP numbers outshine their production of real cash profits. Second, look at the valuation. Leaving aside the issue of the firm's massive debt load, the stock trades at a price-to-free cash flow ratio of 19 today but is projected to grow its profits at just 12.5% long term. That looks a little pricey to me, and whatever improvements Textron makes to its GAAP numbers, it will also need to generate more free cash flow than it already is producing if it's to justify the stock's current valuation.


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What did we expect out of Textron last quarter, and what did it produce? Find out in:

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Fool contributor Rich Smith does not own shares of any company named above.