The aviation and defense industry can be difficult to assess due to its contract-based structure, geopolitical exposure and huge capital expenditures that may or may not pay off. As shown by cases such as the that of Boeing’s (BA, Financial) 737 Max, a high-profile failure can lead to years of underperformance and financial losses for a company in this industry.
However, it is still possible to identify aviation and defense stocks with outperformance potential by looking for key tailwinds such as lucrative contracts, growing backlogs and technological advancements. One overlooked company that is doing well based on these criteria is Textron Inc. (TXT, Financial).
From its humble beginnings as a synthetic yarn producer in 1923 (which was a cutting-edge product at the time), Textron’s predecessor company transitioned to a parachute maker in World War II and then began the process of making acquisitions to become an aviation, defense and industrial products conglomerate. Nowadays, it is home to several industry-leading brands, including Bell, Cessna, Beechcraft, E-Z-GO, Arctic Cat and more.
The company’s key areas of growth are aviation and defense, which are supported by a robust financial business. It recently marked a big defense milestone by winning a U.S. Army helicopter contract for its tilt-rotor aircraft, the V-280 Valor, to replace retiring Black Hawk aircraft, beating out Lockheed Martin (LMT, Financial) and Boeing. The contract could be worth as much as $70 billion over the decades, according to the Army. Textron is also positioning itself as an early leader in sustainable aviation fuel (SAF), which could serve as a long-lasting growth booster as companies look to decarbonize.
Key contract set to drive sustainable revenue boost
A contract worth $70 billion over the next few decades may not be enough to move the needle at a giant like Lockheed Martin, but Textron has a market cap of just $14.09 billion as of this writing, and its revenue for full-year 2022 was $12.86 billion. Out of that, $3.1 billion in revenue came from the company’s Bell division, which houses its military rotorcraft and commercial helicopter operations. In other words, the V-280 Valor could be a significant revenue booster in the coming decades.
The contract has been protested by Lockheed Martin, which asked the U.S. Government Accountability Office to review the decision based on its assertion that Lockheed Martin’s proposal would provide better value to the Army and taxpayers. It should be noted this is just standard procedure and posturing; competitors cannot just take losing a contract at face value without protesting the decision because it would make them look weak and thus decrease their chances of getting more contracts in the future.
According to J.J. Gertler, a senior analyst at the Teal Group Corp., approximately 45% of such protests are successful, likely due to the highly speculative process of trying to figure out which contractor’s proposal is the best combination of value and performance. The results of this particular review are due on April 7, so the GAO’s final decision on the matter should go public soon.
However, a few years ago, Congress made it a requirement for the U.S. Department of Defense to explain to a company why it won or lost a competition, which has decreased the number of protests and increased transparency. “We are confident that the process we went through was disciplined and deliberate and it counted for the complexity of the decision that was involved,” Major General Robert Barrie said on the subject of the Army’s decision to award the contract to Textron.
Sustainable fuel investments could pay off in the long run
Textron’s Aviation division is even bigger than its Bell division, recording $5.1 billion in revenue in 2022. As the demand for aircraft of all types and sizes continues to grow on a global scale, companies are increasingly paying attention to the fuel consumption of their aircraft. Fuel is a significant cost of aircraft operation, and since there is a limited supply of fossil fuels in the world, it is destined to become increasingly expensive in the long run. Thus, aircraft manufacturers that make early moves in sustainable and alternative fuels and fuel efficiency can position themselves better for long-term growth.
All newer Textron Aviation turbine aircraft can operate with sustainable aviation fuel, which is made from renewable and waste feedstocks. While it is not clean-burning, SAF does reduce greenhouse gas emissions on a lifecycle basis. Buyers of certain Textron aircraft can get SAF in their initial tank upon delivery, and the company’s Wichita service center offers SAF refueling. Textron Aviation is aiming for all post-2020 growth to be carbon neutral, and it hopes to cut its carbon emissions in half by 2050.
Textron has also made a move into electric aircraft with its fourth-quarter 2022 acquisition of revolutionary Slovenian aircraft developer Pipistrel for $235 million. Pipistrel now makes up Textron’s new eAviation division. It’s far from being a profitability driver at the moment, as the business reported revenue of $6 million and a net loss of $10 million in the fourth quarter of 2022. However, Pipistrel is famous for having developed a light plane that can fly with an energy cost of as little as 1 euro ($1.10) per hour, and as Textron’s naming of the new division shows, it plans to focus primarily on developing the company’s electric aircraft.
Valuation and takeaway
Despite its promising growth outlook, Textron trades at a price-earnings ratio of just 17.25. Based on analyst estimates from Morningstar (MORN, Financial), the forward price-earnings ratio is even lower at 13.43. This may be due in part to how choppy the company’s bottom line has been historically.
Textron maintains a solid balance sheet with a Piotroski F-Score of 7 out of 9 and an interest coverage ratio of 8.25, and its research and development spending typically runs around the mid 4% range of revenue, which does not break the bank. This strategy may draw criticism in a bull market, but in the current rising interest rate environment, it gives Textron a leg up to invest in growth.
The GF Value chart rates the stock as fairly valued. Despite the stock’s recent upwards trajectory and low price-earnings ratio, it has a volatile history, so the company may need to prove its ability to record significant growth before Mr. Market pays attention.
