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Bear of the Day: Hexcel Corp (HXL)

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Sometimes the price movement in a stock just makes sense. You can observe generally positive sentiment, improving business conditions, expectations for increased revenues and earnings and the fact that the shares are climbing in value seems to be an appropriate response.

Sometimes it’s the opposite. A stock gets hot based on a general theory about a particular industry and the shares rally even though traditional analysis would suggest that things are likelier to get worse before they get better. That certainly seems to be the case for materials manufacturer Hexcel Corp (HXL - Free Report) .

In a typical year between 70 and 90% of Hexcel’s revenues come from selling composite materials used in the manufacture of commercial aircraft. Their next biggest source of sales are parts for wind power turbines. The first half of 2020 was a rough time for aircraft manufacturers and the various suppliers from whom they buy parts and materials.

With demand for domestic air travel dropping precipitiously and much international travel suspended altogether, the major airlines were cancelling routes, furloughing employees and parking their aircraft fleets. They certainly weren’t ramping up their orders for new aircraft.

The most obvious effect was on the manufacturer Boeing (BA - Free Report) , which was already operating under a difficult set of conditions when its most popular and profitable aircraft – the 737 MAX – was grounded worldwide because of  safety concerns after two fatal accidents. Boeing really only assembles aircraft however and it didn’t take long to realize that its suppliers (and those of European competitor Airbus) would suffer as well.

Then things started to turn around.

When Joe Biden won the Presidential election, the prospect of additional fiscal stimulus became more likely and the airline industry is the most obvious potential recipient of financial assistance. Vaccine research promises to return the travel industry to more normal conditions.

After nearly two years, Boeing received certification from the FAA to resume flights of the 737 MAX and expects the workhorse planes to be back in the air at scale in 2021.

For Hexcel, the expectation of a Presidential administration that might be more friendly to renewable sources of energy also made it possible that the wind turbine market would benefit as well.

It all made sense and the markets love a good story. Hexcel shares have rallied 65% from their October lows.  It’s probably a case of moving “too far, too fast” however - because the numbers simply don’t back up the optimistic narratives just yet.

Fiscal stimulus from Congress is still far from certain and even is the airlines do receive assistance, that will simply help them shore up their operational budgets in the immediate term. It may still be a long time before they’re increasing orders for new aircraft. It will be even longer until those orders filter down into the financial results of materials suppliers.

Also, Republicans actually gained seats in the House of Representatives and are favored to retain control of the Senate after two runoff elections in Georgia. Though the general sentiment in favor of alternative energy has improved somewhat, the chances for any sort of sweeping legislation that would directly benefit companies like Hexcel remain small. We'r much more likely to see gridlock.

In the last 60 days, Hexcel has experienced:

A huge earnings miss in which they lost $(0.29)/share instead of the expected $0.07 profit.

Reduced consensus estimates that took the current quarter lower by 30%, the current (2020) year lower by 48% and 2021 lower by 35%.  Those downward revisions earn Hexcel a Zacks Rank #5 (Strong Sell).

And yet the stock has been climbing! Even with the reduced expectations, HXL shares now trade at a forward 12-month P/E Ratio of 130X.

It’s a natural tendency to want to be an optimist – recognizing an opportunity before the turnaround is obvious to everyone and making a profit. In the cases of companies like Hexcel however, it’s important not to let an optimistic story cloud your judgement about questionable fundamentals.

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