Esterline Technologies (ESL) has always been an interesting company to me – a collection of 10 plus semi-autonomous companies focused on aerospace and defense. Since their first quarter earnings report was released on February 28th, the stock has outperformed the S&P 500 (up 5.5% VS 2.5% for the S&P 500), which caused me to dig a little deeper into the earnings report to see if I could find a reason.
First, here is an overview of some key metrics for Esterline over the last few years:
Annual revenue growth is still positive, at a relatively healthy 8.9%. While the revenue growth is slowing faster than I would prefer, at this point I will chalk it up to macro factors rather than to management issues. However this will be a metric to watch closely in future earnings releases.
Trailing 12 month after tax margin has been relatively flat (barring the exception of the impairment charge Racal Acoustics Defense in third quarter 2012), so no big concerns there. However Inventories were up 5% from recent quarters – this is somewhat cautionary as it could indicate future write-downs impacting margins.
Perhaps the outperformance of the stock after the earnings release can be attributed to the new markets Esterline is exploring. With the slowing defense spending, Esterline has announced they have some opportunities in high-speed rail, nuclear power, and gaming initiatives. This must be the catalyst for growth that investors are anticipating, though it seems awfully early to be pricing these opportunities into the stock.
Note what this recent price increase has done to the stocks earnings yield. When I compare Esterline to another defense related company of approximately the same size, Flir Systems, Inc (FLIR), you notice the valuation for Esterline is not as attractive as it once was:
While Flir is not a pure comp to Esterline, this chart does indicate that much of the good news is priced into Esterline.
Conclusion
This quarters earnings report does have reasons for optimism, but I believe the stock may be over anticipating future catalysts for growth. Given the unanticipated US Government sequester (admittedly unanticipated by management), keep an eye on the annual revenue growth. Also keep an eye on the new market opportunities mentioned. Due to Esterline distributed organizational structure, they may be able to move quickly to gain traction. But I would need to see more proof first.
To see the full first quarter earnings report, click here.