Rockwell Collins (COL) has sputtered of late amid a strong run by most aerospace stocks, falling $3 per share overnight last week after announcing results that fell short of expectations. Investors still looking for opportunities in the sector might want to take notice.
While the broader markets were experiencing October turbulence aerospace was on an upswing, propelled on the commercial side by optimistic production forecasts at Boeing (BA - Get Report) and Airbus (EADSY) and on the defense side by a two-year budget deal in Washington that takes away some of the uncertainty about Pentagon outlays. Barclays aerospace analyst Carter Copeland notes that in recent weeks his coverage group outperformed the S&P 500 by 5%, extending year-to-date outperformance, posing the question of whether there is much upside left to find.
Enter Cedar Rapids, Iowa-based Rockwell, a maker of electronics and communications systems for commercial and military aviation platforms that reported both fiscal fourth-quarter and full fiscal-year results that were short of consensus due to tepid commercial aftermarket sales and foreign exchange concerns. The company, an active consolidator, is fighting a perception that growth is always a year away, and worries about troubles with customers such as Bombardier (BDRBF) .
Though Rockwell did forecast a fiscal 2016 that starts slow and builds in the second half, analysts say there is good reason to believe that this time they will deliver. The aftermarket, which Canaccord Genuity Inc. analyst Ken Herbert admits has "lumpiness," still "does present opportunities for upside."
Issues in the defense sector and a slow post-recession recovery of the business jet market plagued Rockwell Collins in the first half of the decade, and investors with a memory of that period are cautious to get involved now. But Barclays' Copeland says that "we think this narrative misses the market," saying that "today's return to growth, while seemingly delayed by a year, is based on several high visibility drivers" that make Rockwell shares "more attractive than most investors assume."
Rockwell is also heavily involved in efforts by cash-flush airlines to improve their cabin experiences with in-flight entertainment and connectivity. The company last year acquired Singapore-based Pacific Avionics Pty. Ltd. for an undisclosed sum specifically to strengthen in this area, which is a focus on airlines attempting to differentiate their product and win customers now that large-scale North American consolidation has mostly been played out.
The company should see results improve as new Boeing and Airbus platforms ramp up production. Analysts also sees potential for Rockwell Collins to benefit from a potential upswing in retrofitting of older models, a possibility that more airlines could consider with wait lists for new planes long and low fuel prices eliminating much of the rational for discarding older models.
M&A could also be in the company's future. Rockwell Collins has been an active consolidator of small assets. Chief Financial Officer Patrick Allen told investors last week the firm's current debt-to-Ebitda ratio, at 1.7 times, "still allows us the necessary cost-effective access to fund our capital needs" including dividends, interest payments "and, hopefully, some acquisition opportunities."
Some observers suggest Rockwell Collins follow in the footsteps of similarly sized defense electronics and communications firm Harris (HRS) , which broke from its pattern of small deals earlier this year and spent $4.75 billion on Exelis in an effort to spark growth. Rockwell in 2013 bought Arinc for $1.4 billion, but most of its purchases have been well under the $300 million level.
Though on paper Rockwell would make an attractive target for a large defense firm seeking to expand its commercial exposure, many of the most likely candidates appear busy with other en endeavors.
One potential bidder, Northrop Grumman (NOC) , might be reluctant to commit to a major purchase for now as it keeps both management attention and its balance sheet focused on the recently awarded $80 billion long-range bomber contract. Raytheon (RTN - Get Report) , which already has a large electronics and communications division, of late has focused its M&A dollars on cybersecurity including its $1.9 billion purchase of Websense.
Rockwell Collins has both great potential and a recent history of false starts. This time it really could be different.