PCP - Precision Castparts Corp.

[compounding]

All is not unicorns and puppies at PCC just because Todd and Lou bought some.  I learned through discussions with industry contacts that PCC division Specialty Metals (SMC) is a huge cluster at the moment.  SMC is reportedly consistently late on product deliveries and all-around disorganized.

 

Always good to start a post with a straw man and then back up your claim with some anecdotal evidence.

 

Perhaps this explains the "planned retirement" of Forged Head Ken Buck earlier this year:

http://www.precast.com/investors/press_release/?id=655

 

I think the harder long-term question it to predict how well PCC nails capacity in a high-volume aircraft upcycle (well-telegraphed and understood by all) where orders have possibly peaked.  The company has massive operating leverage, but this also works against it if OEM newbuild demand doesn't materialize as expected and obviously when the next downcycle occurs (it will).

 

Just curious, how do you go about predicting how well a company "nails" capacity in a cyclical industry?

[fisch777]

Comments on state of operations at SMC were directly from a trusted, close contact who does quite a bit of business directly with the company.  I wouldn't say this is "anecdotal".  I am not bashing the company, just trying to learn strengths & weaknesses.

 

Someone asked about pricing / inventory comments before...

 

Pricing

1/22/15 Donegan: "Deflation is a way of life, what you have to do, it will be constant way of life going forward" “ have been deflationary ever since I’ve been in this job”

5/18/14 Donegan: “we are a company that is constantly in deflationary mode"

 

 

Inventory

1/23/14

From a – you have TIMET side – I think that we are very conscious that the elements of the team are at historically low levels. So from a vantage point, am I willing to invest in that to get material that I can use later on down the road? Yeah. I am. So, let me just state by that, I’m not at this point in time trying to shed material aggressively in the TIMET transaction. I actually would love to get my hands on as much revert as I could now, rutile. Yeah, it’s at historically low points. So I tell you point blank, I’m not shedding inventory nearly as quickly as I would have if we were in a accelerating or higher point from that standpoint. It is a conscious decision. Same would hold true, revert on the metals. Nickel side is the same. So I am capturing – I will get every pound of revert anywhere I can find it and get it on my shelves right now. That’s going to become gold at some point in time.

 

So as you move that forward, again, as you start thinking of metal prices go up, that is when I would probably try to shed some of the material side of the equation. I would love – if I had – if I look at an investment, looking at buying back stock or whatever it is – buying acquisitions, to some degree I view input material very clearly as a – at this point as a great place to put our money that could pay huge dividends down the road. So, it is that side – raw material side of the equation is a conscious decision to go.

[Liberty]

 

Promo video (8 mins) by the company showing some of what they do. Fun to watch, if very glossy-corporate..

 

(thanks to Johan Hjorstsson for pointing it out)

[compounding]

Fisch777, your quotes are from conference call transcripts?

 

Some insider buying recently: http://www.sec.gov/Archives/edgar/data/1643317/000007995815000041/xslF345X03/edgar.xml

 

&

 

FY 2015 10-K is out: http://www.precast.com/investors/sec_filings/ (Couldn't figure out how to post the link to the 10-K)

[fisch777]

Compounding,

 

Yes, quotes are from call transcripts.  I don't exactly know what to make of them. 

 

I think PCC appears to have nice pricing power and negotiation leverage with many customers (my contact at an "industrial" customer backed that up).  On the aerospace side, the company is clearly difficult to displace for oft-discussed reasons, but PCC is operating in an industry where the duopoly of Airbus/Boeing are driving costs out throughout the supply chain, so the degree of pricing power is uncertain (if at all).  This is why I think Donegan makes these comments.  I estimated Boeing (as the assembler) is the ultimate customer of maybe 35-40% of PCC's sales, so clearly Boeing is positioned well from a customer standpoint (although they are effectively doing business through supplier like engine OEMs, wing mfgs, etc).

 

The inventory comments may be one-off as it relates to TIMET and revert - it is hard to tell in transcript.  However, I think the mindset of investing (speculating) in inventory is a warning sign, although I haven't found other evidence of this.

[mateo999]

When hearing a pitch on PCP in April, Ackman asked about 3D printing as a "when, not if" type disruptor to the business.  Those doing the pitching brushed off the notion essentially as ridiculous.  This comes to mind:

 

"We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten. Don't let yourself be lulled into inaction."

 

-Bill Gates

 

And so it begins (from Bloomberg this morning):

 

EasyJet to Use Drones to Inspect Jets, Mulling 3-D-Printed Parts

By Benjamin Katz and Kari Lundgren

(Bloomberg) -- EasyJet Plc said it will begin using drones to inspect jets on the ground starting next year and is experimenting with the 3-D printing of replacement parts as it pursues innovations to keep costs down.  The airline said it has succeeded in using a drone to inspect one of its planes and will roll out the robots at engineering bases over the next 12 months. The technology is intended to trim the number of hours jetliners are out of service, the Luton, England-based company said in a statement.

 

Europe’s second-biggest discount carrier is looking for ways to use technology to cut costs and trim delays caused by mechanical failures. Technologies under development include three-dimensional printing to replace cabin parts such as armrests, reducing repair times and the need for storage space, and in-flight troubleshooting of technical problems in conjunction with Airbus Group SE, which supplies its planes.

 

“We have made great strides on our work with drone technology,” Chief Executive Carolyn McCall said in the statement, adding that EasyJet is continuing to “look for new and original innovations to help run our operation smoothly.”

 

Drones could be used to pick up damage caused by a lightning strike, the kind of incident that can require a full day of inspections. An overnight delay can cost as much as 15,000 pounds ($23,133), EasyJet has said.

[fisch777]

I would think the sole-source/high-spec/tight-tolerance/gov't approval/extremely high cost of failure/low $ value to total cost of aircraft nature of many of PCP's parts would serve as a barrier to entry to 3D-printed parts, regardless of who makes them, just as it does for traditional competitors who cast/forge parts.

[Spekulatius]

I would think the sole-source/high-spec/tight-tolerance/gov't approval/extremely high cost of failure/low $ value to total cost of aircraft nature of many of PCP's parts would serve as a barrier to entry to 3D-printed parts, regardless of who makes them, just as it does for traditional competitors who cast/forge parts.

 

I don't think 3D printing is a technology to produce high spec parts (like forged parts,structural parts, high strength alloy parts), since it will be difficult to achieve the same physical and mechanical properties, plus quality assurance would be impossible. 3D printing may work for low spec, non critical parts that are needed as one offs or in very low volumes.

[EliG]

Donegan on 3D printing, from Q3 2014 Earnings Call Transcript

 

Ronald J. Epstein - BofA Merrill Lynch, Research Division

 

There's been a lot of discussion lately, and I don't know if it's hype or whatever, about additive manufacturing and 3D printing and potentially what impact that could have on aerospace. Just curious, I mean, what opportunities does that present, if any, for Precision Cast? And I mean, and if you're already playing in it in terms of the powders that you guys do, if you can just give us more color there?

 

Mark Donegan - Chairman and Chief Executive Officer

 

Yes, Ron. I mean, obviously, there is quite a bit of hype or buzz. I mean, if I look at additive manufacturing, it is a process that we've been using for years. When I ran Structures back in '90, we actually started the additive manufacturing process. And we used it for really, before that, we used that to make a tool. And if you get into large structurals, a tool can be in the millions of dollars. And then we would run a part and we would try it and we'd redesign it, and the end customers would go -- and it would be a reiterative process that it wouldn't be uncommon for us to do 10 trials and rework the tool 5 times. We started using it, and we still use it very aggressively today to make multiple parts, 6, 7 parts that we can provide different shapes, configurations to our customers without the investment of tooling. Now there is a very high cost to that model, so it's very good for speed, very good for running. But when you start getting a defined process, the tooling starts to become the way to go, and we get out of the additive manufacturing as quickly as possible. If you take that down the stream kind of to where it is right now and you apply it against our particular components, we do use it in some cases to make cores. We do use it sometimes to make a shell, again to try it out. As soon as we can get away, it becomes cost prohibitive on a high-volume basis in today's world. You start looking at the cost of the material, the power to run the machines, the time it takes. The more complex the part is, the longer the time takes because you're going to build it up in small segments. So if I look at, does it have a place? Absolutely. For us, it's been more in the R&D in giving speed, cutting down the cycle times of tool development. But it becomes very costly as an ongoing bank of machines doing a single piece at a time. And we look at this model all the time. We're metals people. We know the cost of making a particular material input. You start off with a huge increase in just the cost of material to begin with. And then from there, you go through a very costly process to make a part. So if I look at for us, on our components -- and there's a lot of components in an engine that we don't make. But if you look at our components through right now, what's going to fly through 2025, all of our value and share in everything is growing [ph] in those programs. So I'd say through that time frame, again, our technology stays well intact.

[mttddd]

I would think the sole-source/high-spec/tight-tolerance/gov't approval/extremely high cost of failure/low $ value to total cost of aircraft nature of many of PCP's parts would serve as a barrier to entry to 3D-printed parts, regardless of who makes them, just as it does for traditional competitors who cast/forge parts.

 

I don't think 3D printing is a technology to produce high spec parts (like forged parts,structural parts, high strength alloy parts), since it will be difficult to achieve the same physical and mechanical properties, plus quality assurance would be impossible. 3D printing may work for low spec, non critical parts that are needed as one offs or in very low volumes.

 

This, 3d printing is good for plastic/other non metal alloys, even then its going to start off as a way to create small amounts of parts I dont think it can really compete with injection molding for larger runs. There is an even longer way to come before it will be able to compare to the quality and strength of forged/cast metal parts.

[karthikpm]

http://online.barrons.com/articles/precision-castparts-shares-offer-a-rare-bargain-1434170220?mod=BOL_hp_mag

 

Kiss of death?

[Jurgis]

http://online.barrons.com/articles/precision-castparts-shares-offer-a-rare-bargain-1434170220?mod=BOL_hp_mag

 

Kiss of death?

 

I think people are being too snobbish when they call Barron's articles kiss of death. Barron's has good ideas. One thing that is an issue is that they succumb to PE creep. If in 2012/2013 they were looking for 20-50% upside on a stock with current 10-12PE, now they are looking for 20-50% upside on stocks with future (2016) 15-17PEs.

 

OTOH, Barron's kicked out the PCP CEO from top CEO list this year, so buying PCP is contrarian to Barron's kiss of death, no? ;)

 

Disclosure: I have small position in PCP, not buying, not selling here. I generally like Barron's. Can't stand Donlan editorials though.

[CorpRaider]

The Hough guy often comes up with good ideas.  Been following him since the SmartMoney days and have gotten interested in his ideas a few times.  It would be hard to come up with a brilliant ringer of an idea on a weekly basis.

[Phaceliacapital]

http://www.flightglobal.com/news/articles/paris-avio-building-new-technology-layer-by-layer-413712/

 

"The additive layer manufacturing (ALM) process behind those blades is an Avio specialty. Since the Turin-headquartered aero engine components maker was acquired by GE Aviation in August 2013 for $4.3 billion it has been the focus of a steady drive by both parent and subsidiary to bring ALM technologies to commercial fruition."

 

Looking at PCP's margins in that area, something will have to give and my guess is it will not be extremely positive for PCP. GE is coming for their margins.

[undervalued]

What is stopping PCP to copy cat if that method is successful?

[Phaceliacapital]

How does copycatting protect their margins?

[undervalued]

How does copycatting protect their margins?

 

In the short term, they can't.

[rishig]

http://www.flightglobal.com/news/articles/paris-avio-building-new-technology-layer-by-layer-413712/

 

"The additive layer manufacturing (ALM) process behind those blades is an Avio specialty. Since the Turin-headquartered aero engine components maker was acquired by GE Aviation in August 2013 for $4.3 billion it has been the focus of a steady drive by both parent and subsidiary to bring ALM technologies to commercial fruition."

 

Looking at PCP's margins in that area, something will have to give and my guess is it will not be extremely positive for PCP. GE is coming for their margins.

 

My understanding of the business is that PCP is really a low cost provider of these products. The margins you see on PCP P&L are not the result of pricing power. In fact, PCP has been a deflationary provider for years.

 

When the current CEO, Mr. Donegan, took over his position in 2002, the aerospace industry was going through a tough period. He made a dramatic move by promising its oligopolistic customers (GE, Pratt & Whitney, Rolls-Royce) that they will receive year after year of deflationary pricing in return for long-term contracts. The increased volume allowed PCP to optimize the cost structure resulting in the high margins you see on the P&L (thanks to the operating leverage).

 

As an example, PCP owns TIMET, the leader in Titanium Alloy manufacturing in the world. It has a 10 year contract with United Technologies to provide all its Titanium requirements.

 

Donegan is ruthless when it comes to cutting costs. The folks at Ruane, Cunniff say that the 3G guys may have a thing or two to learn from Donegan.

 

A manufacturing business such as PCP is a high fixed cost business with tremendous operating leverage. So, when volume dropped in 2010, you would think that operating income would drop like a rock. Yet, Mr Donegan went about doing his magic, and operating income was stable.

 

Today, oil and gas markets are expected to drop 30% yoy, and they account for 6% of PCP sales. Mr. Donegan has already started right sizing the business.

 

As far as competition is concerned, they would have to provide the entire portfolio that PCP does, promise the same deflationary prices (or more) and yet be able to make half the margins that PCP does. I don't see what incentive a customer has on switching out PCP products, especially when the products are used in critical applications (jet engines) and they are anyway receiving a yoy price decrease.

 

In my opinion, the risk of competition is very limited.

[handycap5]

great comment rishig. really helpful.

 

one important element to your narrative and how PCP has done over the last decade plus is the change in the OEM volumes. I think PCP's strategy as you describe it was "leveraged" to the underlying significant increase in volumes (doubling over fifteen years). This "leverage" is unlikely to repeat, though I am hopeful that it will not unwind either.

 

https://en.wikipedia.org/wiki/Competition_between_Airbus_and_Boeing

 

What I don't understand is why the future looks anything like the past. OEM volumes will grow over next 5 years and then flatline (a seemingly reasonable estimate by Aboulafia). Margins cannot improve and may contract. The M&A opportunities may continue or not, but becomes harder with size and wiser competition (i.e. AA). And the OEMs and the tier 1 suppliers are going to try to be much tougher on pricing with PCP in the future. I don't understand how one makes a lot of money owning the stock today. would you comment?

 

https://youtu.be/HE3ASAbkF7s

[rishig]

great comment rishig. really helpful.

 

one important element to your narrative and how PCP has done over the last decade plus is the change in the OEM volumes. I think PCP's strategy as you describe it was "leveraged" to the underlying significant increase in volumes (doubling over fifteen years). This "leverage" is unlikely to repeat, though I am hopeful that it will not unwind either.

 

https://en.wikipedia.org/wiki/Competition_between_Airbus_and_Boeing

 

What I don't understand is why the future looks anything like the past. OEM volumes will grow over next 5 years and then flatline (a seemingly reasonable estimate by Aboulafia). Margins cannot improve and may contract. The M&A opportunities may continue or not, but becomes harder with size and wiser competition (i.e. AA). And the OEMs and the tier 1 suppliers are going to try to be much tougher on pricing with PCP in the future. I don't understand how one makes a lot of money owning the stock today. would you comment?

 

https://youtu.be/HE3ASAbkF7s

 

Thanks for the Aboulafia video.

 

I have several comments:

(1) Boeing / Airbus have backlogs for ~10 years. So if oil prices don't spike, I expect that the new build growth may continue for a while.

(2) But say if it doesn't, like Aboulafia pointed out, the re-engining will most likely continue. You get the best bang for your buck on re-engining an old aircraft. Many PCP products go into the engine, their biggest customer is GE. So, new build slow down does not necessarily mean a slow down for PCP.

(3) PCP also sells to power industry and oil and gas. I would think that the cycle turns around and provides a buffer in case the aerospace cycle turns.

(4) Management thinks they can do $3 to $5 billion in acquisition in the next few years. That is a 30 - 50% boost in revenues. They have a pretty good record of making 15% on their invested capital. It's hard to say where the acquisition will come from.

 

If you look past the non-cash write down in Q4 2015, they are trading at ~16x P/E. That implies a 6% yield. Conservatively, they can organically grow at 4% for the next decade. That gets you a 10% forward return.

 

If you use a discount rate of 10%, PCP is trading at fair value if all it can do is 4% organic growth. Mr. Market, at current prices, is putting no weight on management's ability to do accretive acquisitions.

 

Disclosure: Long PCP

[Phaceliacapital]

My understanding of the business is that PCP is really a low cost provider of these products. The margins you see on PCP P&L are not the result of pricing power. In fact, PCP has been a deflationary provider for years.

 

When the current CEO, Mr. Donegan, took over his position in 2002, the aerospace industry was going through a tough period. He made a dramatic move by promising its oligopolistic customers (GE, Pratt & Whitney, Rolls-Royce) that they will receive year after year of deflationary pricing in return for long-term contracts. The increased volume allowed PCP to optimize the cost structure resulting in the high margins you see on the P&L (thanks to the operating leverage).

 

As an example, PCP owns TIMET, the leader in Titanium Alloy manufacturing in the world. It has a 10 year contract with United Technologies to provide all its Titanium requirements.

 

Donegan is ruthless when it comes to cutting costs. The folks at Ruane, Cunniff say that the 3G guys may have a thing or two to learn from Donegan.

 

A manufacturing business such as PCP is a high fixed cost business with tremendous operating leverage. So, when volume dropped in 2010, you would think that operating income would drop like a rock. Yet, Mr Donegan went about doing his magic, and operating income was stable.

 

Today, oil and gas markets are expected to drop 30% yoy, and they account for 6% of PCP sales. Mr. Donegan has already started right sizing the business.

 

As far as competition is concerned, they would have to provide the entire portfolio that PCP does, promise the same deflationary prices (or more) and yet be able to make half the margins that PCP does. I don't see what incentive a customer has on switching out PCP products, especially when the products are used in critical applications (jet engines) and they are anyway receiving a yoy price decrease.

 

In my opinion, the risk of competition is very limited.

 

Very interesting, thank, where did he mention those contracts? Conference calls? Or is this nonmaterial nonpublic information you received from PCP employees?

 

In terms of competition, I wouldn't think other suppliers come into play, just manufacturing in house.. Stuff like this: http://cmuscm.blogspot.be/2013/02/a-reversal-from-outsourcing-ges.html which you also see happening at Boeing and others...

[rishig]

My understanding of the business is that PCP is really a low cost provider of these products. The margins you see on PCP P&L are not the result of pricing power. In fact, PCP has been a deflationary provider for years.

 

When the current CEO, Mr. Donegan, took over his position in 2002, the aerospace industry was going through a tough period. He made a dramatic move by promising its oligopolistic customers (GE, Pratt & Whitney, Rolls-Royce) that they will receive year after year of deflationary pricing in return for long-term contracts. The increased volume allowed PCP to optimize the cost structure resulting in the high margins you see on the P&L (thanks to the operating leverage).

 

As an example, PCP owns TIMET, the leader in Titanium Alloy manufacturing in the world. It has a 10 year contract with United Technologies to provide all its Titanium requirements.

 

Donegan is ruthless when it comes to cutting costs. The folks at Ruane, Cunniff say that the 3G guys may have a thing or two to learn from Donegan.

 

A manufacturing business such as PCP is a high fixed cost business with tremendous operating leverage. So, when volume dropped in 2010, you would think that operating income would drop like a rock. Yet, Mr Donegan went about doing his magic, and operating income was stable.

 

Today, oil and gas markets are expected to drop 30% yoy, and they account for 6% of PCP sales. Mr. Donegan has already started right sizing the business.

 

As far as competition is concerned, they would have to provide the entire portfolio that PCP does, promise the same deflationary prices (or more) and yet be able to make half the margins that PCP does. I don't see what incentive a customer has on switching out PCP products, especially when the products are used in critical applications (jet engines) and they are anyway receiving a yoy price decrease.

 

In my opinion, the risk of competition is very limited.

 

Very interesting, thank, where did he mention those contracts? Conference calls? Or is this nonmaterial nonpublic information you received from PCP employees?

 

In terms of competition, I wouldn't think other suppliers come into play, just manufacturing in house.. Stuff like this: http://cmuscm.blogspot.be/2013/02/a-reversal-from-outsourcing-ges.html which you also see happening at Boeing and others...

 

All information is from public sources (PCP website, 10-k, transcripts).

 

It's possible that some manufacturing may be moved in-house, but PCP has a vast portfolio of products and some of it is extremely hard to replicate. I am not super concerned about this.

[Guest notorious546]

Precision Cast Parts reported first quarter fiscal 2016 results which included EPS of $2.87 below Bloomberg consensus estimates of 3.07. Sales for the quarter were 2.412 billion slightly below Bloomberg consensus estimates of 2.516 billion. The company's fiscal 2016 guidance was relatively unchanged and includes sales at 10-10.4 billion, operation margins of 26.6-27.3%, EPS of 12.25-13.15. The only change to guidance was higher interest costs associated with bond issuance completed in June (recall, 3.29% yield) incremental 33 million in interest costs per quarter for the balance of the year. Based on company guidance, the shares have an ~6% FCF yield.

 

During the quarter, the company deployed ~230 million to repurchase stock and completed 266 million in acquisitions. Recall, the company recently increased its capacity to repurchase shares to 2.0 billion over the next 12-18 months.

http://www.precast.com/investors/press_release/?id=660

 

Investment Cast Products reported an 6% increase in earnings and an 1 % increase in sales. Margins improved to ~37% from 35.8% last year. Forged Products, reported a 34% decrease in earnings and an 8% decrease in sales. Margins decrease to 20.4% from 28.4% last year. Airframe Products reported a 10% decrease in earnings and an 3% decrease in sales. Margins decreased to 28% from 30% last year.

 

I think concerns over oil and gas exposure are overblown on the name. The management team is doing a phenomenal job at allocating capital and expanding the company's portfolio of products. Margins are great and free cash flow is consistent.

 

disclosure long

 

[undervalued]

Can some people who are long in PCP comment about this article about GE Aviation's vertical integration? How much competitive edge will PCP lose once GE has completely integrated their 3D manufacturing process? http://www.gwinvestors.com/wp-content/uploads/2015/07/Rolls-Royce-Mind-the-Gap.pdf

 

The 2012 acquisition of Morris Technologies added key 3D printing technology to GE Aviation’s list

of capabilities. The company spent a couple of years testing out components manufactured

through the additive layer process, particularly ones that were complex and sole-sourced from a

single supplier. Suddenly highly complex, sophisticated components were able to be developed

and manufactured by GE Aviation without significant investments. The company then used this

added capability to have pricing discussions with some of its part suppliers. A couple years later,

GE would add mass additive manufacturing to its components factory in Alabama. This has

achieved two crucially important things for GE.

First, it has allowed the company to replicate components that previously required heavilyspecialized

fabrication technology. We’ve spoken with a retired jet engineer who worked on

multiple major joint-ventured engines in the past, and prior to his retirement in 2008, the fabrication

companies Precision Castparts (PCP) and Alcoa’s (AA) Howmet were the only companies capable

of competitively fabricating many crucial components of a jet engine. In fact, in the 1970s, Pratt &

Whitney invested heavily in an automated casting facility that was able to produce a turbine blade

from a single crystal alloy. After all the development had been completed, it turned out that PCP

was able to fabricate the blades at a much more competitive cost than Pratt could, so the

company transferred the technology and PCP ended up becoming the fabricator despite Pratt’s

best efforts. Additive manufacturing has greatly reduced the competitive edge these fabrication

firms once had.

 

Quoted from page 8.

 

Forgot to attached the url. opps. it's is now attached

[mateo999]

interesting to read the Greenwood long thesis on Rolls Royce.  It talks about how PCP is not well-positioned given the rise of 3d printing.  Even for the complex stuff.