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Rockwell Collins Remains Neutral

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We are maintaining our Neutral recommendation on Rockwell Collins Inc. (COL - Free Report) , the foremost global supplier of communications and avionics equipment for both commercial and military customers.

Rockwell Collins recently reported its fourth quarter fiscal 2012 results, ending September 30, 2012. In that quarter the company reported adjusted earnings of $1.32, beating our expectation of $1.09. Earnings were up 17.0% year over year. GAAP earnings per share during the fourth quarter were $1.06 versus $1.02 in the prior-year period. The difference between operating and GAAP earnings in the fourth quarter was due to a restructuring and assets impairment charge.

Rockwell Collins’ total sales in the fourth quarter of fiscal 2012 were down 2% year over year to $1,266 million. Revenues missed the Zacks Consensus Estimate of $1,324 million. The year-over-year decline in revenue was due to lower sales from Government Systems, marginally offset by higher sales from Commercial Systems.

During the quarter, sales related to aircraft original equipment manufacturers were up 15% year over year to $307 million driven by increased sales of Airbus and The Boeing Company (BA - Free Report) , resulting from higher production rates of the 787, 737 and A320 aircrafts.

For fiscal 2013, Rockwell Collins expects total revenue in the range of $4.60 billion to $4.7 billion. The company expects segment operating margin between 21.0% and 22%. It expects earnings in the range of $4.30 to $4.50 per share. The Zacks Consensus Estimate for the year is at $4.43 per share. It expects research & development expenses to be approximately $1,000 million, with capital expenditure expected to be about $140 million.

Based in Cedar Rapids, Iowa, Rockwell Collins designs, manufactures, and supports software and hardware solutions for aircraft communication, navigation, signals intelligence, and weapons systems as well as surveillance systems. Going forward, Rockwell will benefit with the increase in the number of orders for 737 MAX.

Rockwell Collins is the foremost global supplier of communications and avionics equipment for both commercial and military customers. The company’s balanced exposure to both types of customers allows the company to use government funding to develop products for the dual-end market. The dual-end market leads to higher volume sales, which create economies of scale in cost-sensitive government contracts. In the near term, the Surface solutions portfolio will shore up demand from military customers, while recovery in the business and regional jet market will boost commercial sales.

Rockwell Collins has a strong balance sheet when compared to peers with a low long-term debt-to-capitalization of 37.7% as of September 30, 2012 (Zacks industry average was 44.3%). The company continues to be a strong cash generator with operating cash flow of approximately $534 million during the twelve-month period ending September 30, 2012. The company as of September 30, 2012 had cash and cash equivalents of $335 million, and an $850 million revolving credit facility that matures in 2016. Total long-term debt of approximately $779 million is mainly in the form of fixed rate instruments with no significant near-term maturity.

Management has rewarded shareholders by returning a substantial portion of its free cash flow through share repurchases and incremental dividends over the years. In fiscal 2011 and 2012, the company repurchased approximately 5.5 million and 13.3 million shares of common stock at a total cost of $322 million and $723 million, respectively. This leaves $481 million of authorized share repurchase pending. This puts the tally of shares repurchased since 2002 close to 76 million for approximately $3.7 billion.

However, we expect growth of the business aviation market to be hampered by slower global economic recovery.

Also, Rockwell Collins generated 93% of revenues in fiscal 2012 from fixed priced contracts, exposing the bottom line to cost over-runs. As a result, the company will be able to make a profit only if costs stay under the contracted price.

Finally, a large percentage of Rockwell Collins’ business is generated outside the U.S. (33% of sales in fiscal 2012). However, as most of the company’s products are of dual-use (military and commercial), acceptance of contracts are governed by laws, regulations and policies of the U.S. government. The recent performance of the Government Systems segment has been lackluster given the adverse impact from delayed funding authorization and termination of certain programs because of shifting budget priorities.

We have thus maintained our Neutral recommendation on Rockwell Collins. The company currently retains a Zacks #3 Rank (short-term Hold recommendation).

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