This defense and aerospace company beat analysts’ estimates by $0.02 last quarter, and forecasts for this year are for 14.5% growth.
Hexcel Corporation (HXL)
From Canaccord Genuity Research
We are upgrading the shares of Hexcel Corporation (HXL) from Hold to BUY and increasing our price target from $70 to $80. We believe HXL represents favorable exposure to the commercial OE cycle (~71% of sales, with greater content on the newer programs), is seeing an acceleration in its 2018-2019 top-line growth, is poised for steady margin and FCF improvement, and, we believe, carries a scarcity value considering its industry leading position in the composites market. We believe the recent softness in the stock provides an opportunity to participate in this strong franchise.
Why now? We believe the acceleration in growth expected in 2018 will continue into 2019, and we believe it will provide HXL better-than-industry growth from its exposure to the commercial OE cycle. Specifically, we currently model in ~10% top-line growth in both 2018 and 2019. We recently met with HXL management, and while the outlook has not changed, we are incrementally more confident in the top-line upside.
We believe much of the downside risk from its significant wide-body exposure is reflected in current build-rate assumptions. Our commercial aerospace outlook implies ~10% growth in 2018-2019 as well, as rates on the 787, A350, A320neo and 737MAX should offset further declines in the A380, A330 and 777. We expect the acceleration in non-aerospace markets will continue into 2019.
Coming off the strong Q1/18 growth in Space & Defense markets, we see upside to the 2018 “stable” outlook (note the 400M represents the primary headwind) but we believe near term, this is more than offset by the JSF and commercial helicopters, and longer term upside from the CH-53K.
The recent pull-back in the shares represents an opportunity to get into a stock that we believe has superior execution, discipline and technological capabilities. The stock is down ~8% since its June 11 peak, reflecting greater risk around the OE cycle, trade and tariff risks, and concern about upside in the A350 program.
While we get pushback on a lack of a positive catalyst for HXL, we appreciate that this is also a strength, and the balance sheet discipline is an asset, and will provide incremental opportunities to invest in organic growth or to accelerate its shareholder returns.
Many investors see the FCF upside as fully reflected in the stock (and note that the stock is not trading at a discount on a FCF basis). But we believe the FCF harvest will support multiples on a relative basis. We see ~$300M for buybacks in the 2018-2020 period, or 400k shares/quarter on average. The company has committed to returning ~50% of net income to shareholders. We currently model just over $150M for dividends in the 2018-2020 period. While a buyback will likely not surprise anyone, we believe it will contribute to positive sentiment, and reflect confidence and discipline with the FCF.
We believe margin assumptions in 2019-2020 can be conservative as new facilities ramp. Very few suppliers, especially in the material space, are improving on high-20%s gross margins and mid-20%s EBITDA margins, without aftermarket exposure. While cycle concerns are the primary risks, we believe HXL is well positioned to out-perform as revenues, earnings and FCF improve in the 2018-2020 period. Our $80 price target is based on the blend of a 21x EPS multiple and a 15x EBITDA multiple, applied to our 2019 estimates.
Ken Herbert, Canaccord Genuity Research, www.canaccordgenuity.com, July 5, 2018