Rockwell Collins (COL) designs and produces communications and aviation systems for commercial and military customers with solutions oriented around navigation, automated flight control, displays, simulation & training, communications and surveillance. 61% of COL’s sales come from the U.S., with the remainder from Europe (17%), Asia-Pacific (10%) Canada (7%), Africa/Middle East (3%) and Latin America (2%).
Strong player in end markets: COL has a strong foothold in global avionics and military fixed wing and helicopter programs. The commercial cockpit controls market is dominated by COL and two other peers, with high barriers to entry. In addition, COL competes primarily with one or two peers in government contracts that range from Manpack Joint Tactical Radio Systems to electronic intelligence programs and simulation and training applications. Management states that the company has gained market share in the past few years, supported by mid-single digit to double digit sales growth in the Commercial Systems segment, while the Government Systems segment’s gains have been led by products and services sold to international governments. Part of the company’s success is due to its commitment to company-funded R&D, which at 5.2% of sales surpasses all of its Aerospace & Defense peer group, except for one.
Growth opportunities: COL’s 5-year plan includes growth in all three segments. In the Commercial Systems segment, which has the highest margin, the company has been awarded many aircraft platform wins. To just name a couple, the company has been awarded new aircraft platform wins in the Boeing 737 MAX and Boeing 777X airplanes, which will begin deliveries to customers at the end of 2017 and 2020, respectively. As a result of expected deliveries, the Commercial Systems’ margins are expected to expand 50 – 100 bps over a 5 year period. The Government Systems segment’s margins are higher for COL than for its peers, according to management, because of the transferability of technology from the commercial side of the business to its government customers who see the value in tested, cutting edge technology. The Government Systems segment is expected to grow sales by low single digits-to-mid single digits going forward, as challenges in that segment have bottomed in FY Q3 2016 with recent success coming from the non-U.S. side of government business. Finally, in the Information Management Systems segment, COL expects double-digit sales growth and expanding margins in the bigger portion of the segment that is in the more profitable aviation-related business. The aviation-related business makes up at least 75% of the segment and its margins are comparable to those of the Commercial Systems segment.
Limited downside risk: COL’s current challenges have been well communicated. Its Commercial Systems segment’s business jet sales have been declining for over a year. On the government System side, the U.S. federal government’s discretionary spending limits, known as the Sequestration, have negatively affected the segment’s sales since FY 2012. COL expects the slowdown in business jet to continue and no improvement will occur any time soon. However, as COL’s customer base in non-business jet includes Airbus and Boeing, sales growth to these important customers for air transport aviation electronics will help offset some of the sales decline in business jet. Additionally, the Government Systems segment’s sales have returned to growth since FY Q3 2016, after multiple years of sales declines. Going forward, COL expects the segment’s sales to continue to grow, driven mostly by non-U.S. government sales, as the Sequestration has put a cap on discretionary defense spending in the U.S. from FY 2012 through FY 2025.
Intense competition: COL operates in industries that are very competitive, often competing against much larger peers. In order to compete effectively, the company has to continually develop new products and services to maintain technological prowess and win new business. If COL is not successful in winning new business, its strong Economic Margins could be negatively affected.
Another economic slump could negatively affect operations: During economic slowdowns, industrial activity weakens and demand for COL’s products and services may suffer.
The first place we direct our clients to get a helicopter view of the investment attractiveness of any firm is on the Company Snapshot page. This page clearly lays out the overall Investment Grade a firm earns A-F as well as the Investment Grades for each of the individual factors that make up the overall Investment Grade. These factors are split into 3 main categories, Valuation, Momentum and Quality. This helps provide an instant understanding of how our model views the company as an investment opportunity and also gives some insight into what factors are driving the overall Investment Grade. On the Company Snapshot page example below for Rockwell Collins, Inc., you can see that the company receives attractive grades across the board, and looks attractive from a valuation standpoint. Each factor is systematic and proprietary to AFG with the expectation of price return which is the smallest weighted factor in the model. Valuation is the largest indicator of alpha and gets the most weight which is why we consult our clients to anchor on valuation. Quality is used as a catalyst to value along with improving operational momentum.
Intrinsic Value Chart:
To understand how well our model has tracked Rockwell Collins, Inc. through time, we provide a chart that shows AFG’s valuation value vs the actual stock price through time. Since AFG has not changed our methodology since inception 21years ago, this data is a representation of the valuation attractiveness of the company at any given point and time.
As displayed in the Intrinsic Value chart below, AFG’s model has done a good job tracking COL and the firm currently looks undervalued. The blue bars in the chart represent the annual trading range for COL, while the grey dotted line represents AFG’s Intrinsic Value for the firm.
Wealth Creation Report:
AFG’s Wealth Creation Report can help shed some light on a company’s ability to create wealth for its shareholders as it displays the firm’s Economic Margin (EM) levels (economic profitability) in relation to its asset growth. Companies that can earn consistently positive EMs like COL, which is not an easy feat, should be encouraged to grow their asset base to maximize profits. If the firm is unable to earn back its cost of capital (Negative EM), we believe that the firm should focus on fixing its profitability issues and earn the right to grow. Negative EM firms that attempt to grow assets often destroy wealth for shareholders as they are just expanding a losing business. It is not a surprise to see that the 3rd chart in the Wealth Creation Report which measures the return vs. the market shows that COL has been a long time outperformer. The company has consistently been profitable (High EMs) and consistently grown its asset base which we believe is the ideal management strategy you’d like to see employed as a shareholder and the market has rewarded COL.