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Hexcel Shares Surged Last Week, but Can They Keep It Up?

By Rich Smith - Jan 26, 2016 at 7:00PM

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Promises of free cash flow are wonderful. Actually producing some cash would be better.

HXL Total Return Price Chart

A booming aerospace market lent Hexcel shares support last year -- but the stock has sunk along with everything else in 2016. HXL Total Return Price data by YCharts.

Booming plane sales around the globe helped buoy shares of Hexcel Corporation (NYSE: HXL) last year. But as the stock market sank in the early weeks of 2016, shares of the aircraft structural materials specialist fell in tandem -- up until Hexcel released its earnings last week, that is.

Announcing full-year fiscal 2015 earnings on Thursday, Hexcel reported that:

  • Sales were essentially flat year over year at $1.9 billion.
  • Operating profit margins expanded by 130 basis points to 17.8%, permitting operating profits to grow 9% despite almost no sales growth.
  • Meanwhile, share repurchases lowered the share count by 1.5%, further growing net profits per diluted share -- up 15% at $2.44 per share.

On the minus side, free cash flow turned negative for the year, with capital spending of $305 million eating up all $301 million in cash from operations. Commenting on the results, CEO Nick Stanage characterized even this disappointing result as a positive, arguing that the cash generated was at least sufficient to pay for "capital expenditures for continued capacity expansion to support our strong growth."

But I'm not buying it.

What comes next?
"Strong growth" in what, after all, is the real question here. Hexcel says that, with the help of new revenue from Airbus's growing A350 XWB and A320neo programs, it hopes to see revenue rise 8.5% in 2016, yielding full-year sales of $1.97 billion to $2.07 billion. Adjusted profits are expected to rise 5% to 10%.

Management did not provide guidance on projected net profits. But based on the midpoint of that guidance range, it would appear that profit margin expansion is not in the cards, and profits will grow only in line with revenue this year.

Finally, the company expects to return to cash-profitability, if only just barely. Hexcel targets free cash flow somewhere between $20 million and $60 million, implying a level of cash profitability that might equal what it generated in 2014 -- but probably won't.

What comes after what comes next?
Longer term, of course, the hope is that all this capital spending will pay off -- say, around about 2020 -- in supporting annual sales of $3 billion, and net profits of $4.50 per share.

Management also hopes to generate a total of $1 billion in free cash flow (FCF) over the course of 2015 to 2019. If things work out as planned, that averages out to about $200 million per year ... or $250 million a year if you don't count 2015 (in which no free cash was generated) ... or more than $310 million a year if you don't count 2015 or 2016 (in which it now sounds like almost no free cash will be generated for two years running).

What it means to investors
With Hexcel currently valued at $4.5 billion in enterprise value, that works out to an EV/FCF ratio of14.4 in the "good" years of 2017-2019, and 22.5 times FCF across the entire five-year period. Unfortunately, neither of those valuations look particularly attractive in light of consensus analyst expectations for 11% annualized profit growth over the next five years.

Accordingly, I'm at a bit of a loss to explain investors' enthusiasm for Hexcel stock, as reflected in the 10% surge in stock price that followed last week's earnings report. Simply put, no matter how well 2015 worked out for Hexcel, this stock is no bargain.

Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on Motley Fool CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 249 out of more than 75,000 rated members.

The Motley Fool has no position in any of the stocks mentioned. 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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