GenCorp (NYSE:AJRD) shareholders received new marching orders Monday morning. After selling off their stock by 1.7% in response to apparently disappointing earnings news Friday, investors are bidding up GenCorp shares at a frantic pace in Monday trading. Indeed, after gaining nearly 6%, the stock has already recovered all of its Friday losses, and then some. But why?
Let's find out, beginning with the numbers GenCorp reported last week:
- Fourth-quarter sales down 9% year over year to $439.6 million...
- but operating profit margin nearly three times the year-ago tally, at 8.3%...
- resulting in a net profit of $0.15 per diluted share -- versus the year-ago loss.
- But full-year sales up more than 15% at $1.6 billion...
- with operating profit margin plummeting to just 0.8% for the year...
- resulting in a $0.91-per-diluted-share loss for 2014.
I suppose you could call these "mixed" results that justify Friday's sell-off. But that still doesn't tell us why investors are now hopping back on board GenCorp, and lighting up its stock like a rocket.
Seeking a logical explanation for the turnabout, we turn next to GenCorp's free cash flow number -- the amount of actual cash profit the company produced last year, as opposed to its apparent "loss" under generally accepted accounting principles. For the year, GenCorp said it produced $107 million in positive free cash flow, almost all of which appeared in the fourth quarter. That's compared to just $14.4 million in free cash flow produced in all of 2013.
Looked at that way, therefore, it appears GenCorp got something out of its $1.6 billion in sales booked last year. Going forward, there could be more where this came from.
GenCorp said its funded backlog of work to be done (i.e., future revenue for the company) swelled to $2.2 billion through the end of November 2014. That's a 29% increase from 2013, and nearly twice the already-respectable pace of revenue growth seen in 2014. It suggests GenCorp might grow even faster in future years than its 2014 sales number indicate -- perhaps even faster than the 20% profit growth rate analysts have attached to the stock.
What it means to investors
So should you buy GenCorp? It depends. If you're a pure "P/E" investor, then the company's total lack of trailing profits could certainly give you pause. That said, when I look at the company, I see a stock selling for just over 10 times trailing cash profit (according to S&P Capital IQ data), and expected to grow its profitability at 20% annually over the next five years. That is a most attractive valuation.
Viewed more conservatively, of course, GenCorp's 2014 free cash flow production appears to be a bit of an outlier. Over the past five years, the company's free cash flow has averaged closer to $72 million than to last year's $107 million. But even working off that average cash production, and giving GenCorp no credit at all for 2014's stellar performance, it works out to a price-to-free cash flow ratio of 15.5. That is not at all bad for a projected 20% grower.
In fact, to come up with a "good reason" to sell GenCorp stock, as investors did on Friday, I have to both ding the company for its below-2014 free cash flow production and factor in its net debt load of over $500 million. Only then does the valuation rise to nearly 22 times free cash flow, and only then does GenCorp begin to look pricey.
Long story short: I'm with the majority on GenCorp today. There are minuses in the valuation picture, sure. But I still see more pluses.