November 5, 2009
Research Associate: Vinita Gupta, M. Fin
Editor: Sweta Killa, M. Fin.
Sr. Ed.: Ian Madsen, CFA; ; 1-800-767-3771, x9417
111 N. Canal Street, Suite 1101●Chicago, IL60606
Hexcel Corp. / (HXL - NYSE) / $11.08*Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report:3Q09 Earnings Update
Prev. Ed.:Sept. 28, 2009, Coverage Initiated by One Broker (brokers’ material considered till Sept. 23, 2009)
Brokers’ Recommendations: Neutral: 75.0% (9 firms); Positive:25.0% (3); Negative: 0% (0) Prev. Ed.: 6; 4; 0
Brokers’ Target Price: $13.66 (↑$0.10 from the previous report; 10firms) Brokers’ Avg. Expected Return: 23.2%
*NOTE: Though dated November 5, 2009, broker material and share price are as of November 3, 2009.
NOTE: A Flash Update was done on October 26, 2009 (3Q09 Earnings Update; misses expectations)
Note: The tables below (Revenue, Margins, Earnings per Share, and Balance Sheet) contain less broker material than the broker material used in the Valuation table. The extra figures in the Valuation table come from reports that did not have accompanying spreadsheet models.
Portfolio Manager Executive Summary
Hexcel (HXL or the Company),based in Stamford, Connecticut, a vertically integrated company,is a manufacturer of advanced structural materials operating intwo segments: Composite Materials (79.4% of Revenues) and EngineeredProducts (23.0% of Revenues). Composite Materials manufactures carbonfibers, prepregs, honeycomb, among other products, while EngineeredProducts are completed composite components.
25.0% (3out of12) firms in the Digest group are positive, while the remaining75.0% (9out of 12) have a neutral stance on the Company. Most of the firms used DCF, PE and EV/EBITDA multiples to value the shares.
Bulls: Buy or equivalent outlook (3/12 firms) – Target prices range from$13.00-$25.00: These firmssee HXL as a late cycle aerospace player growing faster than its supplier peers as it benefits from the production ramp in composite rich aircraft, combined witha significant opportunity for margin expansion.The firms believe that the Company has a long-term financial visibility (backlog of over $6.0 billion in commercial aircraft) and appears well-situated as a supplier into an emerging wind market that will undergo a secular transition toward increased composite material usage. In addition, these firms believe that the Company continues to have substantial long-term opportunities to expand, attributable to a growing penetration of composites in civil and military aircraft.
Cautious: Neutral or equivalent outlook (9/12 firms) – Target prices range from$10.56-$13.00.While these firms recognize the long-term secular growth story in composites gaining share of new aircraft, the firms also believe that the story is on hold as new programs are continuously delayed. Furthermore, the Wind business remains challenged by a lack of financing, and 15% of Hexcel’s Defense business is F-22 and C-17, the ramp-down of which will impact the Company before F-35 becomes meaningful. These firms suspect that customer inventory destocking in commercial aerospace markets and the very weak conditions in regional/business jets will likely continue for a couple more quarters. Given the current macroeconomic environment and the state of the Company’s end markets, the firmsdo not expect the sharesof the Company to see an earnings multiple expansion until investor sentiment in the commercial airline industry returns and the anticipationof an increase in new airframe build rates for Boeing, including the B787, and Airbus, especially the A380, becomes apparent. With the uncertainty in EPS due to build/productionthe firms prefer to remain on the sidelines.
The firms believe the following additional factors should also be taken into consideration for investing in the stock:
- Hexcel Corporation is a leading integrated producer of advanced structural materials for global commercial and militaryaerospace markets.
- In addition to commercial aerospace applications, which account for over half of the revenues,Hexcel's products are widely used in the manufacture of a variety of end products such as wind turbine blades andrecreational products.
- The Company competes with several U.S.-based and international companies. Cytec Industries of the United States and the Toray Group (a conglomerate) of Japan are the two key competitors of Hexcel on the composite side of the business.
- Currently, the Boeing and Airbus backlog stands at approximately 7,000 aircraft but surplus airline fleet capacity and challenging financial performance will lead to deferrals and cancellations.
- Good cost controls, which include temporary plant shutdowns, workingcapital management and stretching capacity expansion plans over alonger term have helped support free cash flow generation.Going forward, firms in the Zacks Digest expect free cash flow to increase 224.0% y/y, and decrease 103.1% y/y and 1133.3% y/y for FY10 and FY11, respectively.
General Outlook
Firms expect the short term to remain challenging due to inventory management by HXL’s customers, weakness in regional and business aircraft markets, and credit market impacts on HXL’s industrial customers, but the fundamentals for longer term composites growth remain the same. Several firms believe that the longer-term secular growth story of HXL remains extremely attractive as aerospace and a host of other industries, such as wind, displace traditional metallic materials with lighter and stronger but more expensive fiber composites. The firms refer to commercial aerospace as a super cycle business as the confluence of emerging market demands high-fuel prices, strong passenger growth, and the launch of several new platforms (A380, B787, and A350), which led to three years of record order flow and backlogs. While the Company's business model is not recession proof, HXL is providing composite materials for growing end markets, where adoption is likely to increase (even accelerate) due to operational efficiency improvements that are being realized in various end markets. Some firms believe that HXL’s headwinds include inventory destocking along the aero supply chain and weak order intake at wind turbine manufacturers which negatively impact margins. The firms in Zacks Research Digest project a three-year revenue and EPS CAGR (2008-2011) of -3.0% and -5.9%, respectively.
November 3, 2009
Overview
Hexcel Corporation (HXL or the Company) was founded in 1946 and is based in Stamford, Connecticut. The Company together with its subsidiaries is a leading developer and manufacturer of advanced structural materials. HXL develops, manufactures, and markets lightweight, high-performance reinforcement products, composite materials and composite structures for use in the commercial aerospace, industrial, space and defense, and electronics markets. The products are used in a wide variety of end applications, such as commercial and military aircraft, space launch vehicles and satellites, body armor, wind turbine blades, printed wiring boards, high-speed trains and ferries, cars and trucks, window blinds, bikes, skis and a wide variety of other recreational equipment. HXL is a manufacturer of advanced structural materials operating in two segments: Composite Materials (81% of Revenues) and Engineered Products (19% of Revenues). Composite Materials manufactures carbon fibers, prepregs, honeycomb, among other products, while Engineered Products are completed composite components.
The analysts have identified the following factors for evaluating the investment merits ofHXL:
Key Positive Arguments / Key Negative Arguments- High revenue: HXL has the best revenue visibility among its peers, with commercial aerospace, wind and certain defense project backlogs standing at record levels.
- Competitive position: HXL can grow faster than its supplier peers as it benefits from the production ramp in composite-rich aircraft, combined with a significant opportunity for margin expansion.
- Change in product mix:HXL ultimately derives benefits depending upon a number of factors: the design requirements of its customers, the suitability of products against similar products offered by HXL’s competitors, and the requirements of customers and their subcontractors’ awards. HXL’scontinuing change from metals to composites will continue to increase average revenues per aircraft over time.
- Changes in aircraft purchasing pattern:Curtailment of expenditures by the U.S. government and commercial aircarriers will have a negative effect on HXL’s ability to grow revenue and earnings.
- Quarterly fluctuations: Due to the lengthy selling and manufacturing cycles and the nature of product installation, HXL’s quarterly revenues may be difficult to predict, which could have a disproportionately adverse effect onquarterly EPS.
- International business risks: Sales to foreign customers could have a negative effect on results as fluctuations in exchange rates could impact results.
- Customer concentration: Boeing and EADS, parent of Airbus and their respective contractors represent about 40% of total sales and loss of any such significant customer would have a negative impact on results.
- Program delays: Inability to manufacture or deliver new aircraft designs on anticipated schedules could lead to penalties and damages.
Further information on the Company is available at its website:
Note: HXL’s fiscal references coincide with the calendar year.
November 3, 2009
Recent Events
On October 26, 2009,HXL announced its 3Q09 financial results. Highlights are as follows:
- 3Q09 net revenue was $257.1 million, down 22.4% y/y from $331.4 million in 3Q08.
- 3Q09 adjusted operating income was $17.9 million, down 51.1% y/y from $36.6 million in 3Q08.
- 3Q09 pro forma EPS was $0.10, down 54.5% y/y from $0.22 in 3Q08.
Revenue
3Q09Digest total revenue was down 22.4% y/y and 7.3% q/qto $257.1 million versus $331.4 million in 3Q08and $277.3 million in 2Q09, inline with the Company’s press release.
Provided below is the summary of revenue as compiled by Zacks Digest:
Revenue ($ in Million) / 3Q08A / 2008A / 2Q09A / 3Q09A / 4Q09E / 2009E / 2010E / 2011EZacks Consensus / $262.0 / $1,104.0↓ / $1,144.0↓
Digest Average / $331.4 / $1,327.2 / $277.3 / $257.1 / $262.1 / $1,103.8↓ / $1,151.9↓ / $1,210.5↑
Digest High / $331.4 / $1,345.6 / $277.3 / $257.1 / $275.0 / $1,116.7↓ / $1,373.7↑ / $1,285.0↑
Digest Low / $331.0 / $1,324.9 / $277.0 / $257.0 / $240.0 / $1,081.7↓ / $1,079.8↓ / $1,163.5↑
Y/Y Growth / 17.9% / 13.3% / -22.9% / -22.4% / -10.1% / -16.8%↓ / 4.4%↓ / 5.1%↑
Q/Q Growth / -7.8% / -9.8% / -7.3% / 2.0%
HXL operates through the three following marketsegments:
Commercial Aerospace
According tothe Zacks Digest model, in 3Q09, the segment’s revenue was down 27.7% y/y and 7.4% q/q to $127.7 million. On a constant currency basis, revenue was down 27.0% y/y. Customer inventory adjustments that begun earlier in FY09 continued in full force resulting in exaggerated sales declines, particularly for Airbus programs.
Sales to other commercial aerospace, which include regional and business aircraft customers, decreased more than 50.0% y/y as a result of announced production cut-backs in this sub-segment that began to be felt from 2Q09.
In 3Q09, revenues attributed to new aircraft programs (A380, A350, B787, B747-8) were modestly higher than y/y as the A350 and 747-8 offset the 787 delay impact but still represents less than 15.0% of the commercial aerospace sales.
One firm (ThinkEquity) believes that air traffic isshowing some signs of stabilization with Airbus and Boeing indicating that the industry is beyond the trough. However, it believes that outlook is for at least another quarter of sluggishness before any restocking of inventory would begin.
Industrial
As per the Zacks Digest model, in 3Q09, the segment’s revenue was down 30.5% y/y and 15.1% q/q to $55.1 million.On a constant currency basis, revenue was down 27.9% y/y.
Wind energy sales, decreased more than 25.0% in constant currency. Firms believe that existing and new wind turbine projects are being hampered by difficult credit markets, particularly in Europe.
HXL carbon fiber shipments for USEC’s American Centrifuge Project were suspended in August 2009, while funding and contractual discussions continue.
Management believes that clarity in the American Recovery and Reinvestment Act (ARRA) of 2009 will help restart order flow in the U.S., (where HXL just had first sales of qualified material from new Windsor, Colorado facility) but global financing availability remains a concern for the next few quarters.
One firm (ThinkEquity) believes that the wind segment has been challenged over the past two quarters due to thelack of credit available. However, there has been some stabilization in thedomestic market. The firm expects a modest recovery in the U.S. that will benefitHXL in the upcoming quarters given the relationships with market leadersVestas and Gamesa.
Another firm (KeyBanc) expects that wind sales should start to see some improvement in the U.S. market, although softness in the Company's primary European market will be a drag for a few more quarters.
Space & Defense
In 3Q09, the segment’srevenue, as per the Zacks Digest model, was down 1.4% y/y and 0.1% q/q to $74.7million. On a constant currency basis, the segment’s revenue were approximately flat y/y. Firms believe that rotorcraft sales continue to be a strong contributor and along with the eventual ramp-up of the Joint Strike Fighter are expected to help offset the impact of the potential wind-down of the F22 or C17 programs, which combined represents about 15.0% of this segment.
One firm (ThinkEquity) expects this business to remain healthy in the quarters ahead.
HXL operates through the two following business segments. The segment details as per the Zacks Digest model are as follows:
Composite Materials
3Q09 Digest revenue declined 27.6% y/y and 9.0% q/q to $198.9 million.
Engineered Products
3Q09Digest revenue declined 2.7% y/y and 1.4% q/q to $61.2 million.
Corporate & Other
3Q09 Digest revenue increased 34.1% y/y and 3.2% q/q to ($6.0) million.
Provided below is the summary of revenue segments as compiled by Zacks Digest:
Segment Revenue ($ in Million) / 3Q08A / 2008A / 2Q09A / 3Q09A / 4Q09E / 2009E / 2010E / 2011EComposite Materials / $274.8 / $1,098.8 / $218.6 / $198.9 / $204.9 / $869.4↓ / $860.8↓ / $926.0↓
Engineered Products / $62.9 / $249.7 / $62.0 / $61.2 / $62.3 / $250.2↑ / $262.1↑ / $285.4↑
Corporate & Other / ($9.1) / ($40.2) / ($6.2) / ($6.0) / ($6.0) / ($28.0)↓ / ($25.0)↑ / ($28.0)↑
Provided below is a graphical representation of the segmental revenue as compiled by Zacks Digest:
Conclusion: Given current trends,the firms on an average expect sales contribution from Composite Materials to decrease from 81.0% in FY08 to 76.0% in FY11 with a 3 year CAGR(2008-2011)decline of 5.5%. The firms expect sales contribution from Engineered Products to increase from 19.0% in FY08 to 24.0% in FY11 with a 3 year CAGR (2008-2011) growth of 4.6%.
The Department of Energy (DOE) rejected a loan application for USEC’s construction of the American CentrifugePlant. The rejection is expected to derail USEC’s plan to build the nation's second uranium enrichment facility withdemobilization expected to begin immediately. The project was expected to generate $100.0 million in revenues in itsIndustrial segment over the 3-4 year period from 2009-2012 with the greatest share ($40.0 million) in 2009 and 2010.
Management expects business to remain challenging in the near term due to inventory management by its key aerospace and wind customers, weakness in regional and business aircraft markets, and credit market impacts on its industrial customers. HXL indicated that business in 4Q09 will come back to the 2Q09 levels.
One firm (ThinkEquity) expects at least another quarter of inventory destocking in the commercial aerospace supply chain base. However, there have not been further cuts to narrow body build rates by either Airbus or Boeing.
Another firm (Wedbush) believes that with an unchanged outlook from Boeing and regional jets, down 50.0% versus the year ago period, revenues will remain flattish sequentially, as commercial aerospace customers aggressively manage inventory levels heading into 4Q09 and 1H10. In its Industrial business, the Company continues to see struggles in its wind energy business due to the difficult credit markets.
Another firm (Deutsche Bank) sees a moderationand eventual elimination of inventory headwinds, the new challenge in 2010 willbe declining in production rates at Boeing/Airbus and key program ramp-downsin Space & Defense (F22 and C17) offsetting upside from new programgrowth (787, F35, V22) and Wind production ramp-up. Therefore,the firm does not see a sharprecovery and project a downside for a few more quarters.
Please refer to the Zacks Research Digest spreadsheet for more details onrevenue estimates.
Margins
3Q09 Digest gross profit was down 26.7% y/y and17.4% q/q to $52.1 million. Gross margindecreased 120 bps y/y and 250 bps q/q to 20.3%.Firms believe that q/q gross margin was down attributable to significantly lower volumes which more than offset the y/y operational improvements, cost controls and headcount reductions.
3Q09 Digest operating income decreased 46.1% y/y and 35.7% q/q to $19.4 million. 3Q09 Digest operating margin increased 340 bps both y/y and q/q to 7.5%.
3Q09 Digest SG&A was down 4.0% y/y and increased 2.3% q/q to $25.8 million. The y/y decline wasattributable to lower spending and aided by the weaker Euro and British pound.3Q09 Res. & Dev. Exp. increased8.9% y/y and 31.2% q/q to $8.3 million. 3Q09, Research and technology expenses of $8.4 million were about 20.0% higher y/y on a constant currency basis, primarily attributable to higher qualification costs for new programs.
Provided below is the summary of margins as compiled by Zacks Digest:
Margins / 3Q08A / 2008A / 2Q09A / 3Q09A / 4Q09E / 2009E / 2010E / 2011EGross Margin / 21.5% / 21.9% / 22.8% / 20.3% / 20.3% / 22.3%↓ / 22.4%↓ / 22.4%↓
Operating Margin / 10.9% / 10.8% / 10.9% / 7.5% / 8.5% / 10.1%↓ / 10.7%↓ / 10.4%↓
Pre-tax Margin / 10.2% / 9.3% / 8.1% / 4.9% / 5.6% / 7.7%↓ / 8.2%↓ / 8.6%↓
Net Margin / 7.3% / 6.6% / 6.2% / 3.9% / 4.1% / 5.5%↓ / 6.1%↓ / 6.4%↓
Provided below is the summary of operating income segments as compiled by Zacks Digest:
Segmental Operating Income / 3Q08A / 2008A / 2Q09A / 3Q09A / 4Q09E / 2009E / 2010E / 2011EComposite Materials / $39.3 / $161.5 / $30.6 / $20.9 / $22.9 / $119.9↓ / $107.1↓ / $115.4↓
Engineered Products / $6.6 / $26.8 / $9.9 / $7.9 / $8.2 / $34.4↓ / $35.8↓ / $41.4↑
Corporate & Other / ($10.1) / ($55.7) / ($10.3) / ($9.0) / ($9.0) / ($45.0)↑ / ($38.0)↑ / ($38.0)↑
Total Operating Income / $36.0 / $142.9 / $30.2 / $19.4 / $22.2 / $111.4↓ / $123.3↓ / $126.2↓
The segment details as per the Zacks Research Digest are as follow:
Composite Materials
3Q09 Digest segment’s operating profit was down 46.9% y/y and 31.8% q/q to $20.9 million.
Engineered Products
3Q09 Digest segment’s operating profit was up 20.6% y/y and decreased 20.4% q/q to $7.9 million.
Provided below is a graphical representation of the segmental operating income as compiled by Zacks Digest:
Conclusion:Given current trend, firms on an average expect contribution fromComposite Materials operating income to decrease from 86.0% in FY08 to 74.0% in FY11 with a three-year CAGR (2008-2011) decline of 10.6%. The firms expect contribution from Engineered Products to increase from 14.0% in FY08 to 26.0% in FY11 with a 3 year CAGR growth of 15.6%.
One firm (Wedbush) believes that unchanged outlook from Boeing andAirbus will struggle into 1H10 with margins harder to hold given lower volumes.There remains significant uncertainty and a wide range of views regarding new aircraft build schedules into 2010.
Another firm (Macquarie Research) expects margins to recover modestly in 4Q09, assuming continuedvolume weakness more than offsetting cost control efforts.
Brokerage firms expectSG&A to decreaseat a slower rate versus adecrease in revenuey/y inFY09 (5.9% versus 16.8%). The firms expect SG&A to decrease versus an increase in revenue y/y in FY10 (-1.8% versus 4.4%) and increase at a slower pace in FY11 (3.7% versus 5.1%).This accounts for deteriorating margins for FY09but increasingmargins in FY10 and FY11.
Brokerage firms expectR&D expenses to decrease at a slower pace compared with a decrease in revenue for FY09 (6.5% versus 16.8%). The firms expect R&D expenses to decrease versus an increase in revenue y/y in FY10 (-5.1% versus 4.4%) and increase at a faster pace in FY11 (8.5% versus 5.1%), respectively. This accounts for deteriorating margins for FY09 and FY11 but increasing margins in FY10.
Please refer to the Zacks Research Digest spreadsheet for more details on margin estimates.