Textron Cruising With A Healthy Backlog, But Turbulence Seems All But Inevitable
Contributor since 2011 / 19714 Followers
Summary:
- Textron is in a tricky place today, as the bizjet cycle is likely past its peak, the FLRAA win is some distance from full production, and macroeconomic headwinds pressure Industrial.
- The FLRAA contract win was crucial for Bell’s viability, and there’s significant upside from potential add-orders and/or foreign sales, but it’s tough to model given long timelines and order uncertainty.
- Bizjet orders remain healthy, but more moderate expectations are advised as the segment faces a potential cyclical downturn and macro pressures.
- Long-term revenue growth around 6% and improving margins/FCF generation can support a fair value in the $90’s, but I’d like more upside given the potential business risks and headwinds.
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Once companies are in a good position with respect to backlog and future business prospects, Wall Street often turns to speculating as to how and when it will start to go wrong. While that may be a bit of an exaggeration where Textron (NYSE:TXT) is concerned, bullishness over the future benefits of the Future Long Range Assault Aircraft (or FLRAA) contract win is definitely tempered by concerns that the business jet cycle is nearing its end.
Up about 25% since my last update, Textron has actually modestly underperformed the broader industrial sector over that time, though it has outperformed comps like Dassault (OTCPK:DUAVF) and General Dynamics (GD) by about 10%. Trying to time cycles like bizjets with any real precision is usually pointless, but I think it’s fair to say that this cycle is closer to its end than its beginning. Even factoring in the benefits of the FLRAA deal, this looks more like a hold to me than a buy at this point.
FLRAA Should Provide Years Of Stability To Bell
Textron is already ramping up operations to support the initial phase of its FLRAA contract win, with the company currently focused on delivering physical prototypes for flight testing. Assuming that the testing meets the Army’s requirements, meaningful deliveries should start in 2030.
With past projects like the H-1 basically over, the FLRAA win is crucial to maintaining the viability of Bell as a business; the commercial helicopter business is just not large enough to sustain the business, and military projects have long been a critical driver for it.
The FLRAA is meant to replace UH-60 Black Hawk, produced by Lockheed Martin’s (LMT) Sikorsky division, and given that Lockheed Martin produced over 5,000 of the helicopters during the program’s run, it’s easy to get to large numbers for the potential value of the FLRAA contract (I’ve seen quotes of $70B).
The initial proposal calls for 600 aircraft, but not only is there room for the Army to order additional aircraft (I believe there are over 2,800 Black Hawk helicopters still in service), there is also the distinct possibility of selling FLRAAs to other countries. Over 30 countries operate Black Hawk helicopters (included unexpected operators like Afghanistan and China), and seven other countries operate at least 50 (including Japan at over 200).
This is tricky to model now, though. First, there are no guarantees that FLRAA will go into production, go into production on schedule, or that the military will order as many aircraft as originally expected. That leads to a biotech-like modeling exercise of modeling out various production volumes and then assigning probabilities to them to generate a present-day value.
Bizjet Orders Are Still Healthy, But More Moderate Expectations Seem Healthier Now
The Aviation segment at Textron has been the source of more than a little angst lately. While orders have continued to grow, it hasn’t been an unbroken path and the segment has missed sell-side expectations for revenue for five straight quarters. With the bizjet expansion phase already long in the tooth, and macro pressures mounting, analysts and investors are understandably concerned that this critical business is about to see its cycle roll over.
At some point that will happen, but I would note that the backlog in the last quarter was only a little below the recent peak (less than 2%) and the book-to-bill appeared to be something on the order of 1.2x. Textron has about 18-24 months of revenue in the backlog now, and I don’t expect orders to fall to zero in the coming quarters.
Deliveries and profitability should, in fact, improve some from here. Like other OEMs in the aerospace sector, Textron has had to deal with a host of supplier issues that have constrained the company’s ability to operate at full production and maximum efficiency. With those issues largely in the past now, deliveries (and thus revenue) and margins should improve from here.
Restructuring Industrial Doesn’t Really Answer Longer-Standing Issues
Management did talk about weakness in its high-end customer base last quarter, and while I think extrapolating that to the bizjet business is quite a stretch (the wealth needed to own and operate a jet is quite a bit different than an ATV), I do think the Industrial segment is likely to see some pressure for a little while longer.
On the Specialty Vehicle side (ATVs and the like), higher borrowing rates and weaker consumer confidence are already impacting sales, with the Industrial segment down about 4% in the first quarter. On the Kautex side, the outlook for auto production in 2024 continues to weaken, and that’s not going to help this tier one auto supplier.
Management launched a restructuring late in 2023, and while I don’t want to sell management short, I don’t think that’s going to be enough. Margins have never been great in this business (I think the peak was around 9%, and that was almost a decade ago) and I think the company could do better things with the capital it has tied up here.
Management has pursued “strategic options” in the past without finding a buyer, and it took Ingersoll Rand (IR) years to find a buyer for Club Car, but I do think this is a segment management would do well to look to dispose of if a decent deal can be found.
The Outlook
On the whole I still like Textron’s business. I don’t expect a sharp down-cycle in bizjets; I do think sales are at or near a peak, but there are still arguments for bizjets given declining airport and airline service quality. I am bullish on the prospects of the FLRAA project, and I also think Textron’s Systems business will win at least some of the projects its bidding for among drone vehicles (airborne and land), munitions, and other programs.
I’m looking for long-term revenue growth of around 6%, and there is certainly upside if FLRAA exceeds expectations and/or Textron secures other notable wins. With improving conditions in Aviation and future leverage from FLRAA, I’m expecting EBITDA margins to improve from the low double-digits (around 11% the last three years) to 12% this year and toward the mid-teens over the next five years. In free cash flow terms, I expect free cash flow margins to improve from the mid-single-digits toward the high single-digits, driving high single-digit free cash flow growth.
Between discounted cash flow and margin/return-driven EV/EBITDA, I think Textron is modestly undervalued today. I will again acknowledge the possibility that greater FLRAA volumes could drive more revenue and FCF than I expect, and likewise the bizjet cycle could stay stronger for longer. On the other hand, I think it’s prudent to consider risks like a sharper correction in the cyclical bizjet business and FLRAA orders that don’t meet expectations.
The Bottom Line
I believe Textron’s fair value is in the $90’s, and that doesn’t really inspire me to strong feelings either way about the stock today. If you believe the bizjet cycle will last longer and/or you’re particularly bullish on FLRAA, or you just don’t mind holding on to a cyclical name through its ups and downs, there are reasons to own it today, and I think the management team here is a good one. I just don’t see enough upside, though, to take on the cyclical risks of bizjets at this point in the cycle, nor the idiosyncrasies of government defense procurement, and it’s a name I’d reconsider at a better risk/reward ratio.
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