Dividend Stock Analysis – PCP

[UPDATE 11/12/2014: The SeekingAlpha version of this article is available here!]

Being a much younger investor than most, I always love reading about those who’ve already “made it”. I like hearing about retirees who, through the power of wise investing and compounding, have generated enough passive income to live the life they want, free of financial worry. I was reading an article about one such investor, Stephanie T. Mucha, 97, who is a millionaire several times over, despite earning roughly $23,000 a year during her working career. When talking about her investment philosophy, she mentioned something interesting: “[y]ou can’t build without nuts and bolts”. When you think about it, you really can’t; everything from semiconductors to trains to computers will have something with the proverbial “nuts and bolts” in it. If not the product itself, the machines used to make it will. With that in mind, I decided to take a deeper look at one of the companies she recently invested in, Precision Castparts Corp. (NYSE:PCP).

Quick Background:

Quoting from PCP’s company website:

Precision Castparts Corp. is a worldwide, diversified manufacturer of complex metal components and products. It serves the aerospace, power, and general industrial markets. PCC is the market leader in manufacturing large, complex structural investment castings, airfoil castings, forged components, aerostructures and highly engineered, critical fasteners for aerospace applications. In addition, the Company is the leading producer of airfoil castings for the industrial gas turbine market. PCC manufactures extruded seamless pipe, fittings, forgings, and clad products for power generation and oil & gas applications; commercial and military airframe aerostructures; and metal alloys and other materials to the casting and forging industries.

The company was founded in 1953, and is based in Portland, Oregon. It is #322 on the Fortune 500. 26% of revenues come from “structural investment castings”, mostly for airplane engines and the general aerospace sector, although PCP does have exposure to the medical implants industry. Investment casting involves using ceramic molds to make very specialized, precise, and complex parts, such as the fan, compressor, and turbine of airplane engines. 44% of revenues come from forged titanium- and nickel-alloy products, sold to the aerospace and power generation industries. The last 30% of revenues come from fasteners and “precision components”, which include products meant for the construction, oil & gas, mining, maritime, and recreational products industries. 68% of sales come from aerospace, 18% from power generation, and 14% from “other”. The company’s main competitors include Allegheny Technologies (ATI), Carpenter Technology Corp (CRS), and Illinois Tool Works (ITW).

For more basic information, check out the company’s website and the 2014 annual report.

Fun fact: An investment of $10,000 in December 2000 would be worth $126,944.55 today, all dividends reinvested. This yields an annual rate of return of 20.1%. (Source: FAST Graphs)

Investment Criteria:

So now that we have a basic understanding of who PCP is and what it does, let’s run our basic screening criteria on it, with the help of David Fish’s US Dividend Champions List:

• Pays a dividend: Yes
• Has 5+ years of dividend increases: No (Constant dividend since 2005)
• Has not frozen dividend for over 8 quarters: No
• Has a Chowder number of 12 or more: No (0.05)
• Has am EPS payout ratio of less than 70%: Yes (0.7%)
• Pays a dividend monthly or quarterly: Yes (Quarterly; March, June, September, December)

Well, it appears that PCP isn’t really a dividend growth stock. Is PCP a solid company anyway? From FAST Graphs:

• Has an S&P Quality Ranking of ‘A-‘ or better: No (B)
• Has generally increasing earnings over the past 10 years: Yes
• Is fairly valued/undervalued according to the Normal P/E ratio (blue line): Yes
• Is fairly valued/undervalued according to the Intrinsic P/E ratio (orange line): Yes

Other Bonus Ratings:

• S&P Capital IQ: 5-star strong buy
  • Scale is 1-5, 1 being ‘strong sell’, 5 being ‘strong buy’
• Thompson Reuters StockReport: 7 (optimized score of 3)
  • Scale is 1-10, 10 being best, 1 being worst
  • Optimized scores weight insider trading and price momentum heavier than other criteria
• Value Line: 1 for safety; 3 for timeliness
  • Scale is 1-5, 1 being best, 5 being worst

Financial Overview:

The dividend is solidly in why-even-bother territory. The payout is $0.12 annually, so that PCP yields 0.05% at current prices. The dividend has been held constant since at least 2005. If it’s any consolation, in the 2014 10-K, PCP’s management states that “[w]e expect to continue to pay quarterly cash dividends, subject to our earnings, financial condition and other factors”. The company doesn’t reward shareholders via share repurchases either. The current share count is 142.53 million, versus 135.1 million in 2006, indicating that PCP is a net issuer of shares. The company’s debt is well under control. PCP has a debt-to-equity ratio of 23.8%. Debt stands at $3.572 billion. Equity value is $11.413 billion, and total asset value is $18.586 billion (Source). The dividend, such that it is, is in no danger of decreasing. PCP has also split 3 times in the past few decades: a 3-for-2 split in 1994, and two 2-for-1 splits in 2000 and 2005.

The P/E ratio is fair at 17.7, and Morningstar has a one year forward P/E ratio of 14.4, suggesting solid growth in earnings. Compared to its peer group, PCP’s gross, operating, and net profit margins are all better (34.76% vs 21.63%, 28.39% vs -1.77%, and 18.8% vs -3.45%) (Source: Scottrade). Finally, Morningstar rates the economic moat as ‘narrow’ and leadership as ‘standard’. The few competitors that exist are old and entrenched, but significant. The possibility of a new upstart using current technology is unlikely, since such technology is highly specialized and expensive. That does not preclude a new competitor from using a new type of technology to encroach on the big players’ turf, but again, based on the nature of the industry, it is unlikely.

For the next five years, it is projected that PCP’s earnings will grow 14.4%, and that the estimated total return will be 7.0%, which is a decent, but not impressive, return as-is. For comparison, ATI’s five year ETR is 26.2%, CRS’s is 25.3%, and ITW’s is 6.7%. This hints that PCP will underperform its peer group in the next few years (Source: FAST Graphs). It should be noted that the two companies that will outperform PCP are much smaller, each having less than 1/10th the market cap of PCP.

Risk Factors:

The company is somewhat specialized in the customers it serves; the 2014 10-K mentions GE, Pratt & Whitney, and Rolls-Royce as major customers. All of these customers have been with PCP for several decades. While relying on a few major customer is never ideal, the strength and history of each relationship is a strong positive. PCP also focuses heavily on customer service and constantly tries to exceed their strict criteria for products. This means that each relationship is “sticky”; it would be a lot of hard work for an individual customer to vet a new supplier and ensure that their products are of the same caliber as PCP’s.

Another risk is inventory stockpiling and lower demand for PCP’s products. Quoting from Morningstar:

During the financial crisis, customers’ inventory destocking caused revenue and margin pressure at the company. Many of its products are inputs into other interim products, resulting in potentially unmanageable channel-inventory issues. For example, its casting division manufactures parts for aircraft engines. These parts are sent to engine manufacturers such as GE, who will complete the engine. However, GE’s customer may have delayed engine acceptance due to decreased demand for new airplanes. This causes GE to build inventory of engine parts, resulting in lower future orders for PCC, at least over the near term.

Some good SeekingAlpha articles on PCP can be found here (bullish) and here (bullish).

Final conclusion:

I do not believe PCP is an attractive investment, according to my criteria. It’s pretty clear that management is not exactly shareholder-friendly, in the sense of an ExxonMobil or AT&T. The dividend is trivial, and probably won’t be increased any time soon. It’s not a “cannibal” either, as shares outstanding have increased over the past decade. So if you’re looking for a true income-producing asset, PCP isn’t the company for you, end of discussion. But if you want some growth, let’s take a step back a bit. Aerospace as a sector looks quite appealing around now. Boeing has an airplane backlog of 5,070 units. Airbus has a similar backlog of 5,559 planes. And that just includes the two main players! This may be an interesting place to make an investment. PCP is less risky than an airline, and sells to all the major players in aircraft manufacturing. So if you don’t look at PCP as an income-producing dividend stock, and perhaps view it as a solid, well-positioned growth stock in a growing industry, PCP doesn’t look bad as an investment at all. If you are willing to invest in growth stocks, and have some room in your portfolio, it may be worth going long PCP.

What do you think? Does PCP make the cut for your portfolio? Also, how can I improve future analyses?

Disclosure: None.

All data is accurate as of market close, 11/10/2014. My stock analysis archive page has been updated accordingly. Please read my disclaimer here before choosing to invest. Company logo image source is available here. Data source is FAST Graphs or company materials, unless otherwise indicated.

Tags: dividend-stock-analysis, PCP, Precision Castparts Corp