Wednesday, September 02, 2009

Textron (NYSE:TXT): Upgraded to Conviction Buy at Goldman Sachs

Goldman Sachs is upgrading Textron (NYSE:TXT) to Conviction Buy from Neutral and raising price target to $23 (prev. $16)

All of TXT’s cyclical businesses (Cessna, Industrial, TFC) are at or near trough and likely turning the corner, valuation is compelling, and catalysts lie ahead. The three key drivers of the upgrade are:

1) business jet data likely keeps improving in 2H09/2010,

2) Industrial could surprise to the upside near-term given that 60% of revenue is from Autos, and

3) continued credit and capital market improvement means more run-off success, potential asset sales, and liquidity enhancements.

The following could act as positive catalysts and drive shares higher, 1) TXT’s Analyst Day on Sept. 9, 2) improved Auto production driving upside at Industrial, given that 60% is Auto, 3) business jet data continuing to improve, 4) asset sales or additional liquidity related events could occur by year-end as credit markets keep improving.

They have raised their 2009/2010/2011E to $0.10/$1.15/$1.75 from $0.00/$0.80/$1.45, driven by stronger Industrial Auto growth, a faster recovery in Cessna margins, and fewer losses at TFC.

Cessna near the trough
During the 2Q earnings period a number of companies with business jet exposure alluded to early signs of a turnaround in the business jet market; rates of decline in flight hours slowing, inventory levels declining, secondary market values firming, modest order activity coming in, and cancellations declining. Firm's conversations with business jet OEs and suppliers, as well as their channel checks in the market, indicate that conditions have continued to improve further since 2Q end. Goldman therefore believes it is likely that Cessna reports further improvement in order and cancellations rates when it reports 3Q, and makes little to no change to its production forecast.

As shown in Exhibit 1, business jet shipments are highly correlated with corporate profits. Goldman's expectation is that both are at or near the trough. Exhibit 2 shows the Cessna book-to bill, which has been extremely weak YTD as cancellations have meaningfully outpaced orders. They expect book-to-bill to improve moving forward, and the history lesson tells us to buy Aerospace stocks at the order trough

Industrial could surprise on the upside given Auto exposure
With all the focus on the liquidity plan, TFC and the business jet market, it is easy to forget that Textron has an Industrial business, where 60% is Kautex which is a supplier to the Auto industry. Goldman believes the recent uptick in Auto production has the potential to positively impact TXT's 3Q results, and to drive a faster than expected recovery in 2010.

The Defense business has some unique drivers
While the firm maintains a Cautious view of the Defense sector, almost every company in or Aerospace coverage has a Defense component, and they're of the view that Textron's is less meaningful to the total company, and that it has some unique growth drivers that should allow it to continue growing positively, even if they see meaningful declines in broader Defense spending.

Liquidity plan a huge success, TFC losses have likely peaked
To-date the liquidity plan has been substantially more successful than the market anticipated, and they believe Textron now has ample liquidity. With $2.1bn of Distribution receivables left, we believe the cash conversion rate (which has been in the 90% range in both 1Q and 2Q) on the receivable run-off can remain strong for the remainder of 2009, which means another place the firm sees more positive news ahead.

The stock currently trades at 0.6x revenue. If it were to trade at its historical average of 0.95x revenue, there could be even more upside than our price target implies.

Notablecalls: First of all note that Morgan Stanley upgraded TXT to Overweight from Underweight yesterday morning calling for a potential double over the next couple of years. That was a fairly powerful call that sent the stock as high as $16.60 intraday.

And now we have Goldman Sachs out with a Conviction List upgrade calling for a 50% upside in the next 12 months.

That's like getting blessed by the Pope himself.

I think there will be some spillover effect from MSCO's call yesterday as some fund managers and their analysts studied the call and will submit orders today.

All in all I think TXT will fly on this. I'm guessing if the market holds we will see another attempt toward $16.60-.75

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