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Precision Castparts Stays at Neutral

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On Jan 3, we reiterated our Neutral recommendation on Precision Castparts Corp. largely due to modest second quarter fiscal 2014 results. We prefer to remain on the sidelines until we see substantial organic growth and improvement in the overall industry environment.

Why a Neutral Recommendation?

On Oct 24, Precision Castparts reported second-quarter 2014 earnings from continuing operations at $2.90 per share, which beat the Zacks Consensus Estimate of $2.82 by 2.8%. Quarterly earnings were up 27.7% year over year from $2.27 in the prior-year quarter. Despite a sluggish economy, underlying growth across the company’s markets and segments remained strong during the quarter. 

Precision Castparts’ revenues increased 22.6% year over year to $2,362 million from $1,927 million in the prior-year quarter, primarily driven by organic growth of 6%. However, revenues were short of Zacks Consensus Estimate of $2,365 million.

The improved results in the recently reported quarter came on the back of increased demand in the commercial aerospace as well as strong oil and gas businesses. Two of the three reporting segments posted double-digit revenue growth during the quarter. Furthermore, IGT (Industrial Gas Turbine) is also showing good momentum in its aftermarket backlog as the company will be shipping out large quantities of nickel-based, severe service tubular product in the upcoming four quarters. The company expects its major end markets to drive organic growth.

However, the highly seasonal nature of aerospace and power generation markets might prove to be a headwind for Precision Castparts’ business. The demand for commercial aircraft is also being negatively influenced by effects of terrorism, changing global political environment, and U.S. foreign policy. The power generation market is also facing challenges from rising fuel costs, and changing government policies regarding environment control measures imposed on the power generation industry.

Precision Castparts is also focusing on expanding its product lines and markets by pursuing strategic acquisitions. The company completed twelve acquisitions in fiscal 2013, the most recent being that of Permaswage SAS for $600 million in an all cash transaction. These acquisitions contributed approximately $400 million to sales in fiscal 2013. The acquired companies are also expected to benefit Precision Castparts going forward, with improved sales and stronger global market position based on diversity of its operations.

However, the company’s weak cash and balance sheet position might not facilitate sufficient flexibility to make innovative investments and strategic acquisitions. In the last reported quarter, its cash and cash equivalents dipped about 3.9% compared to the last year’s figures. Thus, we prefer to remain on the sidelines until there is better visibility.

Other Stocks to Consider

Precision Castparts currently holds a Zacks Rank #2 (Buy). Some better-ranked stocks in the sector include Companhia Siderurgica Nacional (SID - Free Report) , ArcelorMittal (MT - Free Report) and Worthington Industries, Inc. (WOR - Free Report) . Companhia Siderurgica Nacional and ArcelorMittal both carry a Zacks Rank #1 (Strong Buy), while Worthington Industries carries a Zacks Rank #2 (Buy).

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