Friday, July 16, 2010

Precision Castparts (NYSE:PCP): Upgraded to Outperform at CSFB

Credit Suisse is upgrading Precision Castparts (NYSE:PCP) to Outperform from Neutral with a $150 (prev. $129)

At the beginning of the year, they began warming up to commercial OE. As Q1 progressed, rate increases instead of cuts became a reality for both Boeing and Airbus. They got more positive and upgraded Boeing and Spirit April/May, but held of on PCP given its pricier valuation and some concern over the longer term sustainability of its superior margin profile. However, CSFB thinks the bearish sentiment on the stock is overdone and the 20% decline in share price since early May is unwarranted. They believe Precision offers one of the best risk/reward profiles in commercial aerospace.

Credit Suisse sees even greater peak earnings power this cycle given its strong positions on new aircraft development programs, market share expansion in both aerospace and power, acquisition integration as well as its aggressive margin protection during the downturn. PCP is highly levered to the OE cycle where visibility has cleared and rates are increasing on both narrowbody and widebody production. PCP has much to gain from Boeing’s new 787 as it has a $5.6M+ position on each aircraft and is looking to earn company average margins from the start, unlike other risk-sharing partners where delays and re-design is pressuring margin on the first block of aircraft.

PCP has experienced heavy destocking during the downturn in both Aero and Power, resulting in orders that were more than 20% below build rates in some cases. However, they believe the visibility has improved and that the stars are aligning for a robust recovery in the second half of PCP’s FY’11 (December 2010 and March 2011 quarters). FQ2, or the September quarter looks to be the transition quarter but in the December quarter a number of key tailwinds will converge for PCP and they expect a steep revenue and earnings ramp. CSFB's FY’11 est. of $7.53 is 10-cents above the street and their FY’12 estimate of $8.69 is now 11-cents above the street. They introduce a FY’13 estimate of $10.25, which is 22-cents above the street.

Upgrading PCP for several key reasons:

1) Greater change in peak earnings power

Among OE names, PCP shld enjoy greatest relative upside in peak earnings power since prior upcycle (2007) due to aforementioned aero OE rev growth, energy industry upside, low defense ex osure & insulation from 787 margin pressure. Plus, PCP is more likely than other OE names (BA/SPR) to supplement org. earnings with accretive M&A given its track record. CSFB FY’12 est. rises $0.07 to $8.69 ($0.11 >street) and they introduce FY’13 at $10.25 ($0.22 >street). They est. peak EPS at $12+ further out.

2) OE pipeline kicking in – new programs, legacy program rate hikes

3) They think concerns on inventory accounting overdone, creating attractive entry point

Notablecalls: This one is a mover and I suspect it will get play today.