In at least one respect, aerospace supplier Rockwell Collins (COL) didn't do too badly last week. True, sales missed expectations slightly. But the company was expected to report fiscal Q1 2016 profits of $1.02 per share Friday, and Rockwell hit that number on the nose, delivering precisely $1.02 per share in diluted earnings. Two straight days of selling then ensued, followed by a bit of a bounce back on Tuesday.
With the stock still down 4% from pre-earnings, it bears asking: Why are investors so upset?
Here's how the quarter went down:
- Q1 sales of $1.17 billion declined 5% in comparison to last year's Q1.
- Operating profit margins slipped 50 basis points to 20.1%.
- A combination of restructuring charges and tax benefits pushed net income down 19%.
- And despite a small boost from a smaller share count, per share profits still fell 18% to $1.02.
Those all sounded like good reasons to sell the stock last week. Yet in commenting on the quarter -- and quarters to come -- management actually seemed pretty optimistic. Sales and earnings in both Commercial Systems and Information Management Services were both "in line with expectations." True, Government Systems sales fell "below our expectations," but mainly because of the "timing" of certain orders, and problems with getting parts from a supplier.
Both those issues are getting resolved. Looking out over the course of the remainder of the year, Rockwell Collins promises that full-year sales will resume growing, profit margins will stabilize, and earnings will not only make up all the growth lost in Q1, but grow for the year as a whole. For the year, management is projecting:
- $5.3 billion to $5.4 billion in sales -- 2% to 4% growth.
- Operating profit margins of 21% -- nearly a full percentage point better than seen in Q1.
- Net earnings ranging between $5.45 and $5.65 -- 11% to 15% growth.
- $550 million to $650 million in free cash flow.
What to do now
If management is right, this paints a much brighter picture than what we saw in Q1. But is this picture pretty to justify buying Rockwell Collins shares today? Well, let's see.
Taken at the midpoint, Rockwell Collins' earnings guidance suggests a current-year P/E ratio of about 15x earnings. If earnings grow 15%, that would imply the stock is trading at about fair value. Unfortunately for Rockwell Collins shareholders, most analysts following the stock do not believe 15% growth is sustainable long-term. Rather, the consensus expectation is that Rockwell Collins will grow its earnings at closer to 9% annually over the next five years.
The picture's even cloudier if you value the stock on its actual cash profits -- its free cash flow -- rather than on reported GAAP earnings. Here, Rockwell Collins' projected $600 million free cash flow implies a valuation of 18 times FCF. Factor in debt, and the enterprise value-to-free cash flow is even higher. Again assuming 9% long-term growth, the valuation thus looks even worse this way.
Long story short, despite losing 7% of its market cap over the past year, and 4% over the past three days, despite assuming a booming aerospace market globally, and taking all of management's promises at face value, Rockwell Collins stock still looks overpriced.