Question:
Could you update us on Precision Castparts (NYSE:PCP)? I know that the stock underperformed in 2014. I know it was kind of slowing down. And in 2015, it preannounced a couple quarters back to back. I was wondering if you could update us on that and if you still see compelling value there.
Greg Steinmetz:
We do see compelling value, but it has been a disappointment. It was supposed to earn $16 a share in the fiscal year that we just started. Instead, management is guiding to something like $13. The difficulty has been confined largely to the forged product segment, which is a very high fixed cost business. So when volume goes against you, you really feel it in the margin. We saw a 900 basis point drop in the margin of that segment last quarter. Furthermore, the oil & gas market has gone against Precision. Management had big plans for the oil & gas business, making very large diameter pipes that are highly resistant to corrosion. Precision is the only company on earth that can make that kind of pipe. Management thought that whatever happens with the oil & gas market, the company would be ready, and it would still be able to sell this pipe because of its compelling value. That did not happen, and the company was late to restructure that business and cut costs. The restructuring is now completed; so things should get a little better. Management was expecting $400 million in revenue out of that pipe business last year and only got $200 million, and it will probably be similar this year.
Another thing that has hurt is that Rolls-Royce is aggressively trying to take inventory out of its system. Rolls had too much inventory because managers were worried about not being able to meet delivery schedules and overdid it on inventory. Now they are cutting back the other way. There have been some other issues. Precision makes a lot of parts for the military. Military spares are down 35%. That was not something that the company foresaw happening in the current fiscal year.
That $16 a share was a number that was derived three years ago and as recently as six months ago management was still talking about $16 a share for this year. But lately management recognized that the world had changed and decided to throw in the towel. In addition to the restructuring I mentioned, the company also wrote down some inventory. This year, Precision thinks it is going to make about $13. I think that is a conservative number. Time will tell.
What we like about Precision and why we are keeping it is, as I mentioned, that it is the only company in the world that can make these large diameter highly corrosive resistant pipes. Precision is also far and away the leader in making powdered metal components that are used in large jet engines. It is the only company that can make certain large structural castings, and there are some other things that only Precision can supply. That gives the company a lot of leverage over its customers. Management is not afraid to use it. So it has a very strong competitive position. We also have what should be a growing market for aerospace.
I was with Boeing (BA) management this week — the company is talking about raising the monthly unit deliveries of the narrow body 737 from 42 a month now to 47, and then to 50-something. That could even go to 60 because the backlog is so big, and there is still an enormous appetite even in China — which, as you know, has a soft economy — to get these planes and get them now. The 787 has gone from 10 a month to 12 and that is going to go to maybe 14. So there is growth there. Precision is seeing that in some of its segments. The company will not see it in other areas because of de-stocking at Rolls-Royce. And the build rate for the 747 is being dialed back. Also there is a transition going on from the old models of the 737 and the Airbus narrow body, the A320, from the current generation to a re-engined version. Precision has had to absorb a lot of development costs along the way as that transition has taken place. But now it is coming to an end.
One thing that I think worries people is that, okay, aerospace is going to be a growing market, but is Precision losing share? We all know that because of Precision’s arrogance in the way it treats its customers — raising prices and making demands on them — they would like to cut Precision down to size. So is there a case of customers taking market share away from Precision and giving it to Alcoa and others? I have looked under as many rocks as I can think of to try to get to the bottom of this and I am not finding the evidence. Maybe I am looking under the wrong rocks, but the fact that I have not turned anything up and the fact that the customers buy under long term contracts which they are locked into, and the fact that competitors are not giving me any examples of how they have taken share from Precision make me think we are okay on the market share question.
If Precision can preserve market share in a growing market, we should be okay, which is why we are still holding the stock. Plus at its current price it is not expensive. It trades at a discount to some other of the big names in aerospace. Before it always traded at a premium.
From Ruane, Cunniff & Goldfarb Investor Day 2015 Transcript Part I.
