Rolls Royce Looking To New Civil Aerospace Deliveries To Lift Cash Flow

Commercial aviation engine suppliers make up a relatively small world, as there are really only a half-dozen companies in North America and Europe that offer competitive solutions, and most of those don't compete across the board. Rolls Royce (OTCPK:RYCEY) is a name that is probably best known for a business it's not even in (the luxury car business is owned by BMW (OTCPK:BMWYY)), but this is the third-largest aircraft engine maker and a significant player in the markets for widebody and business/regional engines.

This is an interesting time for Rolls Royce, as the company is about to see new widebody programs ramp up (which isn't actually that good for margins), older programs wind down (which is bad for margins), and likely not much progress in non-aviation areas like marine. What's more, there are well-publicized challenges with widebody aircraft these days, as many operators are turning to more efficient, more capable next-gen narrowbody planes instead.

Although the next couple of years are likely to remain challenging, and an accounting change will hammer reported earnings (but not cash flow), I believe there's an argument to be made that Rolls Royce shares are priced to generate double-digit total returns from here.

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Rolls Royce Looking To New Civil Aerospace Deliveries To Lift Cash Flow

Investopedia: Honeywell Looking Sweet

Although conglomerates do not always get the benefit of the doubt, Honeywell (NYSE:HON) is showing some of the benefits of managing a broad base of unrelated businesses. Not all of Honeywell's businesses are running hot right now, but the company has a good spread of businesses exposed to the early, middle and late phases of the economic cycle. Honeywell does not have the best growth top-line growth outlook on the Street, nor the best free cash flow margin, but investors should not be quick to ignore this name. 

The Quarter That Was
Analysts have been in a rush lately to raise their estimates on Honeywell, but the company nevertheless surpassed expectations for the fourth quarter. Revenue jumped 12% in the quarter, with organic growth clocking in at an impressive 10% clip. Within the company's segments, Honeywell's largest business (automation/control) was one of the strongest as revenue grew 15% to over $3.9 billion. Transportation was even stronger at 18% growth, while specialty materials grew 12% and aerospace brought up the rear with 6% growth.

The profit side of the income statement was a little harder to evaluate. Gross margin was quite a bit better than last year, expanding almost 340 basis points. Unfortunately, both gross margin and operating margin are impacted by various costs like "repositioning." Consequently, segment operating profit rose just 4% for the quarter, but the company's operating leverage is not as weak as that suggests. (For more, see Honeywell's 2011 Outlook.)

The Look Ahead
Honeywell has been maintaining pretty solid free cash flow production even despite a relatively mediocre environment in the commercial aerospace industry, particular the segment of the marketing targeting larger jets (where Honeywell is relatively stronger). Eventually Boeing (NYSE:BA) and EADS will figure it out, though, and companies like Honeywell, United Technologies (NYSE:UTX), Rolls Royce and General Electric (NYSE:GE) can go back to beating up on each other with the backdrop of a healthier overall environment. Given that aerospace produces the highest operating margins for the company, that is clearly something that Honeywell needs to happen.


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HEICO Flying

Sometimes it pays for investors to turn over a lot of rocks. Aerospace parts and electronic components maker HEICO (NYSE:HEI) does not get a lot of attention and seldom makes the headlines of the major financial press, but that has not kept the company from doing a consistently good job of generating returns on capital or overall growth. With the airline industry in better health these days, investors have taken notice of HEICO's positive qualities and pushed the stock up more than 75% over the past year. 

Another Good Quarter
HEI delivered a solid end to its fiscal year, with quarterly revenue growth of about 18% that topped the high end of analyst estimates. The company's flight support business (the parts business) saw top line growth of 14%, while the electronic technologies division posted 27% reported growth and 7% organic growth. There was no real magic bullet to the growth in this quarter, rather it was more a product of improving markets and the company's execution.

HEI also did well in moving that extra revenue through to higher profitability. The company saw gross margin improve by more than 200 basis points, though higher SG&A spending depleted some of that benefit. Overall, operating income rose 23% for the quarter, as operating margin improved by about 70 basis points. Growth was relatively balanced between the two segments (flight support up 28%, electronics up 20%), though the electronics business is much more profitable as a percentage of sales. (For more, see The Bottom Line On Margins.)

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Can Boeing Afford More Delays?

Patience in a funny thing. Everybody wants a job to be done right, but they also want it done on a timescale that at least approximates the original estimates. Customers appreciate that Boeing (NYSE:BA) is attempting to do something quite extraordinary with the 787 Dreamliner project, but if the company cannot ever deliver the plane, who cares how amazing it is? 

More to the point - is Boeing running the risk of giving unintentional aid and comfort to emerging rivals? Should investors worry that Boeing's scale and technical expertise may all go for naught because the company was too ambitious and customers ultimately settle for lesser planes that rivals can actually deliver?  

More Problems ... Again
Boeing has had no shortage of problems with this new 787 plane. Problems with the Rolls Royce engine (one of the two available; the other being offered by General Electric (NYSE:GE)) got a lot of attention, and now Boeing has suspended test flights after an onboard electrical fire. While the company has not formerly altered the expected initiation of deliveries in the middle of the first quarter of 2011, the Dreamliner is already three years behind schedule and more delays seem more likely than not.

Of course, these delays need to be kept in perspective. There has never been a plane quite like the Dreamliner, and the scale of the engineering challenges are enormous. On top of that, these planes may spend well more than 30 years in service and it is clearly important to get everything right ahead of time.  

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Allegheny Becomes Broader Still

Give credit where it is due - Allegheny Technologies (NYSE:ATI) is not messing around when it comes to its plans to diversify away from stainless steel products and become a more diversified player in advanced alloys and technologically sophisticated components. The latest move is the acquisition of Ladish (Nasdaq:LDSH), a small company that has focused on forged and cast-metal components for the aerospace and defense industry.

The Deal
Allegheny is paying a total consideration of $48 per share to Ladish, consisting of $24 per share in cash and slightly less than 0.46 shares of stock for each share of Ladish. That is a total deal value of about $778 million (prior to the post-announcement moves in the stocks) or slightly more than 14 times Ladish's trailing EBITDA. For Ladish shareholders, it also represents more than a 63% premium to the prior night's closing price, but a roughly 17% discount to the company's all-time high back in mid-October of 2007.

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