Summary
- Curtiss-Wright announced modestly better fourth quarter results, with improved supply chain performance helping the Defense Electronics business.
- CW offers attractive leverage to recovering commercial aerospace markets, healthy defense markets, and improving nuclear power markets, as well as growth in areas like agricultural equipment.
- Long-term revenue growth around 6% and low double-digit FCF growth can support an okay return from here, but Curtiss-Wright could still rerate on its relatively better end-market exposures.
Shopping for bargains in the aerospace isn’t an easy task these days, and about the best you can hope for is to find relative bargains or situations where the valuation may not be ideal but there are opportunities for upside. I believe the latter can apply to Curtiss-Wright ( CW ), as I like the company’s leverage to commercial aerospace, defense, and nuclear power, as well as opportunities to augment growth through M&A, but the valuation isn’t exactly discounted at this point.
A Slight Beat, Helped By Better Performance In Defense Electronics
Curtiss-Wright posted 17% constant currency revenue growth in the fourth quarter, good for a modest 1% beat versus sell-side expectations. Overall aerospace and defense revenue grew 18%, including 20% growth in defense, while commercial market revenue rose about 10%. At the segment level, Aerospace and Industrial revenue rose 12%, beating by 1%, Defense Electronics grew 18%, beating by almost 3%, and Naval & Power grew 20%, missing by about 2%.
Gross margin declined 70bp year over year to 38.6%, as the company continues to face input cost inflation and supply challenges (particularly in electronic components). Operating income rose 24%, beating by about 1%, with margin up 140bp (to 21.1%) and beating expectations by 10bp.
Segment profit grew 22%, with margin up 120bp to 22.7%. At the segment level, Aero & Industrial revenue rose 2%, with margin declining one point to 18.5% (beating by 10bp). Defense Electronics profits rose 33%, with margin up 320bp to 29.7% (beating by 30bp) on improved supply chain performance. Naval & Power profits rose 26%, with margin up a point to 20.3%, beating by 100bp.
Orders rose 5% in the quarter, with broad strength, and that does stand out positively in a quarter where many industrials with more short-cycle exposure are starting to see orders contract. Backlog improved by 19% to $2.6B, giving the company good coverage relative to revenue expectations in the $2.7B to $2.8B range for the next two years.
All told, Curtiss-Wright performed well this quarter. The 10% commercial revenue growth was pretty much on target with the median for the larger industrial sector this quarter, with CW seeing healthy double-digit growth in shorter-cycle businesses and high single-digit growth in its power/process businesses (which should accelerate some from here).
Looking at other comps, 12% growth in the commercial aerospace business was okay, but somewhat unimpressive next to Woodward ( WWD ) up more than 30%, Honeywell ( HON ) up over 20%, Moog ( MOG.A )( MOG.B ) up 18%, and Crane ( CR ) up 15%. On the other hand, aero defense growth of 38% stacked up much better, with most of those comps down low single-digits to low double-digits.
Healthy Trends Across Most Of The Business
I like Curtiss-Wright’s leverage to later-cycle or acyclical businesses like commercial aerospace, defense, power generation, and process industries (chemicals, petrochemicals, oil/gas, et al). While there is some “general industrial” exposure here that is likely to see slowing demand, with the slowdown accelerating as the year moves on, I’m not overly concerned. Off-road vehicle demand should remain healthy, particularly with leverage to markets like agriculture that should remain strong into 2024.
Commercial aerospace is a subject I’ve discussed many times in reference to a range of companies (Crane, Hexcel ( HXL ), Moog, Woodward among others), and I remain positive on this market. While narrowbody build-rates aren’t accelerating quite as powerfully as the bulls hoped, and there are still supply chain issues limiting Airbus ( OTCPK:EADSY ) and Boeing ( BA ) from accelerating production further, the growth outlook across the next three years remains strong, with widebody production likely starting to kick in late in 2024.
Defense is a more challenging market to assess in some respects. I like CW’s leverage to multiple aerospace programs, but I’m more interested in the longer-term exposure to the naval side, as I believe naval defense modernization and expansion is likely to continue (if not accelerate) in response to China. One key unknown, albeit almost certain to be positive to some extent (the downside being “nothing”) is the ongoing military support for Ukraine and how that may lead to increased orders/production depending upon what sort of systems the West is willing to provide.
Commercial nuclear power is another positive driver. Aftermarket demand has been improving and there have been some indications of growing interest in new nuclear construction, with Poland recently moving forward with 3 AP1000 reactors (Curtiss-Wright provides coolant pumps and control rod systems for this reactor type) and potential opportunities with Gen-4 smart modular reactors.
The Outlook
Having successfully completed a multiyear margin improvement initiative that saw adjusted operating margins improve from the mid-teens to the high-teens (and helped drive around 200bp of free cash flow margin improvement), management has shifted its focus more towards growth. I do see opportunities for Curtiss-Wright to leverage its core actuation, control, and sensing capabilities into new markets, and I believe there are opportunities for CW to play a more meaningful role in vehicle electrification (far more so on the commercial vehicle side).
I also expect to see more M&A from here. CW has been a disciplined acquirer in the past and has generally been successful at leveraging these deals, and I could see M&A as a means of facilitating the leveraging of core technologies into new markets – buying companies with actuation, control, or sensing exposure in verticals where CW doesn’t currently compete, and then driving revenue/cross-selling synergies.
While management has shifted its focus from margin improvement to growth, I don’t believe that means that margin leverage is finished. CW has shown in the past that it can gain content with established programs (it has done so with defense aerospace, ground, and naval programs, as well as some commercial programs), and that is typically good for margins, to say nothing of generating operating leverage from the commercial aerospace recovery.
I expect EBITDA margins to reach the 20%’s fairly quickly, and I’m expecting a step up to mid-teens FCF margins in the coming years – an aggressive outlook, perhaps, but one that I think is achievable and that can leverage mid-single-digit core revenue growth (around 6%) into low-double-digit FCF growth
Discounted free cash flow suggests some upside from here toward $190 and a long-term total annualized potential return in the high single-digits. My margin/return-driven EV/EBITDA approach isn’t as favorable with a 13x forward multiple getting me to a low/mid-$170’s fair value, but you could argue that CW’s strong position in healthy markets with high barriers to entry could or should support a multiple above what margins/returns would otherwise support.
The Bottom Line
Curtiss-Wright is a situation where I’m more positive on the company than the stock, though this is a stock that certainly demonstrates how improved margins and returns (ROIC, et al) can drive meaningful rerating over time. Were the shares to pull back 10% or more I’d be a lot more excited, but for now I’d call this is a favorably-inclined hold.
To read my recent articles on some of the companies mentioned in this article, please click here ( CR ), here ( HXL ), here ( MOG.A ), or here ( WWD ).
For further details see:
Curtiss-Wright: Set For Later-Cycle Growth And Priced Accordingly