HXL - Woodward: Flying Too High

2023-11-19 08:45:14 ET

Summary

• Woodward's shares have seen a decent run since spring 2021, but the current valuation at $133 per share is demanding.
• Revenues and earnings have recovered but it took a long while before pre-pandemic performance was matched.
• The company's performance in 2021 and 2022 was softer due to the pandemic, causing hesitation in attaching a premium to the shares in this higher rate environment.

Early in 2021, I offered some thoughts on Woodward ( WWD ) after a tumultuous 2020. On top of the turmoil induced by the pandemic, Woodward announced a mega-merger, which was terminated just a few months later.

What followed was a relatively long period in which the pandemic cast a shadow on the business, with the business only posting pre-pandemic operating performance at this point in time. This delayed recovery has long made shares trade stagnant, but after shares have been unleashed since this spring, it is a demanding valuation which prevents me from getting involved here.

About Woodward

Woodward is a designer and manufacturer of energy control and optimization solutions for aerospace and industrial markets. The company has a long history which goes back to 1870, employs over 7,000 workers with average tenure exceeding ten years, and has global operations in notably aerospace markets which it teams up with all the major partners in the ecosystem. Actual products made by the business include flow control, motion control, combustion control and system control applications.

In a rather short time span between 2016 and 2019, revenues have grown some 50% to $3 billion, with earnings reported at $5 per share. With shares trading at $125 pre-pandemic, valuations were full at 25 times earnings.

On top of the headwinds induced by the pandemic, the company announced a merger with Hexcel ( HXL ) with Woodward's investors set to own 55% of the combined company upon consummation of the merger. The deal with Hexcel was fortunately terminated, as Hexcel was hit harder by the pandemic due to the nature of its business.

Sales of Woodward fell around 30% in the second half of 2020 due to the pandemic and rather flattish results in the first half of the year, as full year sales were down 14% to $2.50 billion with earnings down a dollar to $3.96 per share (adjusted earnings these are).

With net debt of $700 million having come down a bit, and EBITDA trending at $400 million per annum based on the fourth quarter performance for 2020, I did not have major leverage concerns. With earnings power impacted from about $5 per share pre-pandemic to a run rate of $3 per share at the time, I was surprised to see shares trade at levels around $125 in the first weeks of 2021. This felt rather optimistic, although I considered Woodward quality to prevail (in the very long run).

Trading Stagnant

After revenues fell to $2.50 billion in the pandemic year 2020, sales fell further to $2.25 billion in the fiscal year 2021 (which ended in September 2021). Revenues recovered by 6% to $2.38 billion in 2022 as adjusted earnings of $3.24 per share were up from $2.75 per share in the year before, still trailing pre-pandemic levels in a major way.

The company guided for 2023 revenues to grow towards $2.60-$2.75 billion, still trailing 2019 revenues, despite inflationary pressures.

Since early 2021, shares have mostly traded in the lower $100s during that year. Shares have traded in an $80-$120 range during 2022. Trading around the $90 mark in March of this year, shares have actually seen a decent year, now trading at $133 per share, thereby trading within imminent reach of their highs this year.

A Stronger 2023

In January of this year, Woodward reported a 14% increase in first quarter sales, while the company maintained the full year guidance. What followed was a 16% increase in the quarterly dividend to $0.22 per share by the end of January, although this trails pre-pandemic dividends, and results in a very modest yield.

In May, Woodward posted a 22% increase in second quarter sales as third quarter sales were up as much as 30%, as released in July. In November, Woodward posted third quarter results, with growth slowing down to 21%, but still being impressive nonetheless.

Full year sales were up 22% to $2.91 billion, after fourth quarter sales grew some 21%, thereby coming in far stronger than the original guidance for this year. The company posted net earnings of $232 million, equal to $3.78 per share, with adjusted earnings coming in at $4.21 per share. Moreover, momentum was strengthening during the year, with earnings now trending closer to $5 per share.

More so, the balance sheet is in solid shape, as net debt of $583 million looks very manageable in relation to a $475 million adjusted EBITDA number for the year.

The current momentum is more or less expected to be maintained in 2024 with sales seen between $3.10 and $3.25 billion, with earnings seen between $4.70 and $5.15 per share.

What Now?

The reality is that it has taken Woodward until now to replicate the pre-pandemic operating performance (at least in terms of profits) and this is likely the reason for the more stagnant share price action in recent years, although shares have seen a decent run since this spring. With shares now trading at $133, the valuation is rather demanding, however, equivalent to about 26 times earnings.

This is rather steep multiple, and while the current performance is strong, the performance has been softer in 2021 and 2022, with the pandemic causing an overhang for quite an extended period of time.

This experience has taken away somewhat the willingness to attach a premium to the shares, as quite frankly, a 20 times multiple seems generous in this interest rate environment. Such reasoning implies that appeal is only really seen around the $100 mark, levels last seen in April, as I feel absolutely in no rush to fly high with Woodward here.

For further details see: