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Why Precision Castparts Missed Estimates

By Lee Samaha - Jan 22, 2015 at 12:25PM

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Precision Castparts reported a disappointing set of earnings and guidance in its third quarter. Here's why.

Following a preannouncement on Jan. 15, Precision Castparts (PCP.DL) investors were already braced for a disappointing third-quarter earnings report. Wall Street analysts reduced their estimates after the preannouncement, but earnings and guidance still came in lighter than the (reduced) expectations. It was a tough quarter for Precision Castparts -- with organic sales and operating income both up 2% -- so let's take a detailed look at what went wrong in the quarter.

Third-quarter earnings
Here's a quick look at Precision Castparts' earnings and guidance. (In order to demonstrate the impact of the preannouncement on subsequent analyst expectations, I've added the company's earnings estimates prior to the preannouncement in brackets.)

  • Third-quarter revenue of $2.46 billion versus analyst expectations of $2.48 billion
  • Third-quarter adjusted EPS of $3.10 versus analyst expectations of $3.17 [$3.41]
  • Full-year adjusted EPS guidance of $12.80-$12.90 versus analyst expectations of $13.32 [$13.68]
  • Full-year 2016 EPS guidance is below its previously stated EPS target range of $15.50-$16.50, and now closer to analyst estimates of $15.12 [$15.69] 

In short, third-quarter revenue and earnings missed (even the reduced) analyst expectations, and the full-year guidance is light, too. Moreover, management was forced to reduce its full-year 2016 guidance to something closer to what Wall Street's expectations are. So, what is going on with Precision Castparts?

Why Precision Castparts' earnings missed
Management cited four contributing factors that negatively affected trading in the quarter.

First, upgrading a major forging press took longer than expected, but the good news is that the press "is now up and running and fully functional," according to CEO Mark Donegan.

Second, "some of our commercial aerospace customers with December year-ends deferred shipments to January," Donegan said. The key words here are "December year-ends." In other words, Donegan might be inferring that its customers were trying to avoid incurring costs before their year-end in order to increase reported profits for the year. If so, then it's entirely feasible that the shipments will be completed soon. Indeed, Donegan stated, "These deferred shipments will ship in the fourth quarter."

Third, one of its large commercial aerospace customers continued destocking in the quarter. In the previous quarter, the customer's destocking reduced forged products sales by 2.5%. The customer matters. Donegan sounded a cautionary note on the issue: "[O]ur visibility to this aerospace customer's schedules is limited, and further reductions may occur."

Fourth, the company is seeing demand deterioration from its oil and gas distribution customers, and Donegan referred to "significant uncertainties" with its sales to the sector -- hardly surprising given the decline in oil prices.

Segmental earnings
The impact of these factors mainly hit its forged products segment, although airframe products was affected to a degree by the deferred shipments issue.

 MetricInvestment Cast ProductsForged ProductsAirframe Products
Sales ($millions)  632 1,029 798
Sales growth 4% 2% 11%
Operating income 229 239 241
Operating income growth 5% (7%) 12%
Margin 36.2% 23.2% 30.2%
Margin movement (basis points) 40 (230) 30

Source: Precision Castparts presentations. Margin movement is in basis points, where 100 bp = 1%.

However, it's not all doom and gloom. On a more positive note, its industrial gas turbine sales (investment cast products segment) increased by 10%, partly due to growing demand for spares. This could be due to lower gas prices encouraging greater use of gas turbines. If so, it should be good news for General Electric, given its exposure to the gas turbine market.

Moreover, Precision Castparts is a major fastener supplier (airframe products segment) on Boeing's 737 and 787 aircraft, and Boeing is planning to increase production rates on these aircraft. Indeed, the earnings release contained some positive commentary on the subject: "Fastener operations continue to maintain a high level of activity to meet aerospace production schedules."

All told, the company missed earnings estimates and gave cautious-looking guidance. The bulk of the negative impact in the quarter fell on its forged products segment, and it's here that investors and analysts will need to focus their attention.

Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends Apple and Precision Castparts. The Motley Fool owns shares of Apple and General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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