No. of Recommendations: 2
Hi everyone,

Catching up on some earnings.

Raw numbers vs. expectations:

By division: -- that's revenue, operating profit & margin, TTM , broken out by division. Note the rocketing Bell margin and the big turnaround in Cessna margin despite relatively flat revenue over the past few rolling TTM periods. (Sorry about the vertical line on the left; it comes from Excel's freeze pane.)

I was pretty pleased with this quarter. Higher revenue for Cessna YoY with more planes delivered, some nice DoD contract wins in Systems (the military division), and continued progress on getting rid of the financing division. Manufacturing revenue was up 10% and manufacturing net margin was up 120 basis points.

Management didn't raise guidance, however, saying that there is a lot of uncertainty in order flow because of the elections, sequestration, etc. There was a pretty good answer on the latter one when an analyst was asking how Textron might handle the sequestration issue:

Jeff Sprague - Vertical Research Partners - Analyst  
Right. And Scott, can you just share some thoughts on sequestration? You've taken the view that it won't happen. Unfortunately, you're taking that view because you're a logical businessman, right? And we're operating in a world where maybe things aren't so logical. So whether you think it's going to happen or not, what does Textron do if it does happen? How do you posture? Can you do things in advance? Do you even know what sequestration would mean for your businesses at this point?

Scott Donnelly - Textron Inc - Chairman, CEO
Jeff, it is really something at this point you can't plan for because the fundamental flaw in my view of sequestration is it's just bad policy. If people decide that there needs to be a further reduction in the defense budget, and obviously the defense community doesn't like that idea, but even if you are going to take it down, the issue is you surely would never do it in the fashion it is laid out in the sequestration law where you do a -- spread it across everything, every program, every spending item, everything gets hit by a common percent. First of all, it would be a disaster for the government because that means every contract, every work order, everything out there gets impacted, which is going to result in a massive deluge of contract changes, request equitable adjustments, it'd just -- it would cost the government more money than they would ever save. There is actually contracts. You can't just go out there and arbitrarily change contracts without having ramifications. Just from a pure administrative standpoint, you would never do that.

The other course is, if you're going to take more money out -- and I'm not betting against, by the way, that they're going to take more money out. I think that there still could be when they work their way through, I would be very surprised with the lame duck session, but when you get into a new Congress and they actually start to figure out what they got to cut and what they're going to do about the deficit, there could still be further allocation of cuts to defense. But I think you have to let that go work the way it normally does. Just like the first $0.5 billion of defense is already taken where you go to the Pentagon, you go to Congress, say okay, we're going to take out this much money, and there's actually a thoughtful, rational way about what programs get hit, what programs don't get hit, and you proceed down that path. So I think I wouldn't be very surprised if sequestration gets invoked because of inaction in our political process. That wouldn't surprise me a whole lot at this stage of the game. But I think once that hits, there will be some emergency sessions, and people will actually say, okay, if we're going to cut money, here is how we have to do it. Ant the problem with planning for that is you don't know what programs they're going to go to try to take money out. So I don't think it's going to be an across-the-board deal. I think that's an administrative -- it's bad policy. Administratively it's bad. It's bad for defense. But knowing where the cuts ultimately will come at this point would be absolute guess work, and I just don't think we can -- we're wasting our time to even try to do a plan for that.

Baked in expectations from last night's price are 16.9% / 8.5% / 2.5% with a 15% discount rate using $459 MM TTM FCF. FCF is lower than it was a year ago (by 23%). Part of this is because of increased investment in working capital ($120 MM more YTD than the same period last year).

With higher margins, the thesis is still working. Now, revenue just needs to grow at those same higher (or even better) margins and FCF will follow. I'm content with the "middle" position size in the port (as measured by dollars invested) and willing to wait for more of the thesis to move forward.

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