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 Precision Castparts Corp. (NYSE:PCP) makes specialized metal products for the aerospace and power generation industries. PCP's large, complex structural investment castings, airfoil castings, and forged components are used in jet aircraft engines and industrial gas turbines (IGT). Large jet aircraft engines are manufactured by a small number of suppliers, including General Electric, Pratt & Whitney, and Rolls-Royce. Because of the complexity of its castings, and their end-use in dangerous machinery, PCP has long-term relationships with the companies that buy its products. It has been supplying large castings for jet engines to GE for more than 40 years and Pratt & Whitney for 30+ years, while supplying smaller structural castings to Rolls-Royce for over 25 years. PCP's revenue increased by 52 percent in 2007, to $5.4B from $3.5B in 2006.[1] Additionally, total debt increased by 29 percent, from $677 million in 2006 to $873 million in 2007.[2] This was due to a pair of acquisitions in February 2007 - GSC Foundries, Inc. (GSC), formerly a competitor to PCP in producing aluminum and steel structural investment castings, and Cherry Aerospace LLC (Cherry), a manufacturer of aerospace blind rivets and blind bolts. The GSC acquisition enhanced PCP's small structural investment casting portfolio, enabling them to produce both larger aluminum and smaller steel components. [3] Cherry brand products, which are found on all major commercial and military aircraft in production or development today, enhance PCP's position in the aerospace market.[4] PCP uses a number of raw materials to make its castings, including certain metals such as cobalt, titanium, nickel, tantalum and molybdenum, which are found in only a few parts of the world and are available from a limited number of suppliers.[5] Its profits were partially offset by higher raw material costs in fiscal 2007, primarily nickel and titanium, which increased 103 percent and 11 percent year-over-year, respectively.[6] To combat the risk of rising input costs, in May 2006 PCP acquired Special Metals Corporation (SMC), a world leader in the production of high-performance, nickel-based alloys and super alloys. SMC, in conjunction with PCP's existing high performance alloy production facilities in western Australia and the U.S., made PCP the world’s largest and most diversified producer of high performance nickel-based alloys, supplying over 5,000 customers.[7]
[edit] Business FinancialsPrecision Castparts manufactures complex metal components and products primarily for aerospace, power generation, general industrial and automotive markets. It operates in three segments: Investment Cast Products (34% of fiscal 2007), Forged Products (43%), and Fastener Products (23%).[8] Their Investment Cast Products segment includes their subsidiaries PCP Structurals, PCP Airfoils and Specialty Materials and Alloys Group (SMAG). These operations manufacture investment castings for aircraft engines, industrial gas turbine engines, airframes, medical prostheses and other industrial applications primarily in the aerospace and power generation markets. The segment also provides alloys and waxes to PCP’s investment casting operations, as well as to other investment casting companies. Forged Products’ aerospace and industrial gas turbine (IGT) sales are primarily derived from the same large engine customers served by the Investment Cast Products segment, with additional aerospace sales to manufacturers of landing gear and other airframe structural components. In addition, PCP manufactures high performance nickel-based alloys used to produce forged components for aerospace and non-aerospace markets, which include products for oil and gas, chemical processing, and pollution control applications. PCP’s IGT products consist of airfoil castings and high-temperature combustion hardware used in large, land-based gas turbines designed for electrical power generation. In addition, they manufacture structural and airfoil castings for aeroderivative gas turbine engines, which are also used for power generation, as well as for other commercial and military land and marine-based applications. Since industrial gas turbines are primarily used in electrical power generation, castings sales for new IGT engines are tied to the growth of global electricity consumption, while demand for replacement parts depends on the size and utilization rate of the installed base. With the acquisition of SPS Technologies, Inc., PCP has become a leading developer and manufacturer of highly engineered fasteners, fastener systems and precision components, primarily for critical aerospace and automotive applications. Approximately 73 percent of Fastener Products sales come from the same aerospace customer base already served by our Investment Cast Products and Forged Products segments.[9] In this regard, Fastener Products is subject to many of the same market forces as these other two segments. The balance of the segment’s sales derives from automotive and general industrial markets, including farm machinery, construction equipment, machine tools, medical equipment, appliances and recreation. PCP’s sales to the aerospace market of $2,828.4 million in fiscal 2007 increased 37 percent from $2,071.0 million in fiscal 2006.[10] As the graphs below demonstrate, sales to the aerospace market as a percentage of total net sales decreased from 59 percent in fiscal 2006 to 53 percent in fiscal 2007.     In 2007, PCP attained for the third consecutive year record levels of sales, operating income, net income from continuing operations, and earnings per share.[15] These results were driven by exceptional performance from Special Metals Corporation (SMC) following its acquisition, by continuing strong conditions in PCP’s core aerospace and power generation markets, and by cost reduction and operational improvements across all of its businesses. PCP also acquired GSC Foundries, Inc. (GSC) and Cherry Aerospace (Cherry) in 2007, two strategically important tuck-in acquisitions for the Investment Cast Products and Fastener Products segments, respectively. It also added critical production capacity in its investment casting and forging operations to meet the increasing demand for aerospace products. PCP has used strategic acquisitions to extend and deepen its market breadth and one-stop shop capability. Its most recent acquisitions are shown below.[16]
[edit] Key Trends and Forces[edit] Availability of raw materialPCP uses a number of raw materials in its products, including certain metals such as nickel, titanium, cobalt, tantalum and molybdenum, which are found in only a few parts of the world. These metals are required for the alloys used or manufactured in their investment casting, forged and fastener product segments. The availability and costs of these metals are influenced by private or governmental cartels, changes in world politics, unstable governments in exporting nations and inflation. Similarly, supplies of the tool-grade steel they use may also be subject to variations in availability and cost. For nickel and other metals, PCP has long-term contracts with customers that include escalation clauses that guarantee a change in the agreement price if a particular factor beyond control of either party significantly changes the value of the commodity. Shortages of and price increases for certain raw materials they use have can cause a reduction in production, and in turn a decrease in income. Increasing prices of raw material will also increase the price of their products, discouraging prospective buyers.    [edit] Dependence on key customersA substantial portion of PCP’s business is conducted with a relatively small number of large customers, including General Electric Company (GE), United Technologies Corporation and Rolls-Royce. General Electric accounted for approximately 11 percent, 17 percent and 17 percent of PCP’s total sales for fiscal 2007, 2006 and 2005, respectively.[20] No other customer accounted for more than 10 percent of total sales; however, United Technologies and Rolls Royce are close to this percentage and are key customers.[21] A financial hardship experienced by any one of these three customers, the loss of any of them, or a further reduction in or substantial delay of orders from any of them, would have a material adverse effect on PCP’s business. [edit] Defense budgetSales to the military sector constituted approximately 13 percent, 18 percent and 19 percent of our fiscal 2007, 2006 and 2005 sales, respectively.[22] PCP manufactures structural and airfoil castings for aeroderivative gas turbine engines which are used for military land and marine-based applications. Many of their products also go into the engines of military aircraft, and high utilization rates of the aircraft causes the need to replace parts or entire planes, creating more demand for new aircrafts increasing their sales. U.S. defense spending is subject to U.S. Congressional appropriations and to political pressures that influence which programs are funded and those which are cancelled. Reductions in defense budgets or military aircraft procurement or delays in funding will adversely affect PCP’s business. [edit] Demand in the aerospace marketPCP’s commercial sales depend substantially on the production rates of both Boeing Company (BA) and Airbus , which in turn depend upon deliveries of new aircraft. The ultimate drivers of orders and deliveries of aircraft are underlying air travel demand, financial health of airlines, growth prospects for airline capacity, and overall economic growth. The current increase in aerospace demand is dependent on increased spending by foreign carriers and domestic airlines who must upgrade aging fleets. PCP stands to benefit from expected aircraft deliveries by Boeing and Airbus, and from the replacement cycle of aging turbines and aircraft that will be upgraded or overhauled. Any factor that adversely affects the aerospace industry (similar to the tragic events of 9/11 or the SARS travel scare) would likely pressure PCP’s operations and profitability. Bankruptcy of another airline, continued high oil prices, or the possibility of a major terrorist attack threaten to change the course of the recovery in the aerospace cycle and likely impact PCP. [edit] CompetitionPCP is the number one or two supplier in its principal markets. Because its castings use proprietary technologies and are critical to engine functionality, PCP’s customers are reluctant to seek out unproven suppliers. This conservatism shuts the door on potential new entrants; the firm's largest customer, GE, has bought Precision's castings for more than four decades. Given the limited number of competitors in each business and even fewer across the spectrum of services, PCP is less susceptible to pricing pressure than most of its peers. [edit] Investment Cast Products segmentPCP’s principal competitor is Howmet, a subsidiary of Alcoa (AA). Howmet produces stainless steel, superalloy, aluminum and titanium investment castings principally for the aerospace and IGT markets. Howmet is capable of producing investment castings comparable to all but the largest and most complex of PCP’s structural investment castings. Howmet has the financial and technical resources to produce structural castings as large and complex as those produced by PCP, should they decide to do so. In addition, Pacific Cast Technologies (PCT), a subsidiary of Ladish Co. , manufactures large titanium investment castings for jet engine and airframe applications. Many other companies throughout the world also produce stainless steel, superalloy, aluminum or titanium investment castings, and some of these companies currently compete with PCP in the aerospace and other markets. [edit] Forged Products segmentPCP’s largest competitors are Ladish Co. and Thyssen AG for aerospace turbine products, Alcoa Inc. and Schultz Steel Company for aerospace structural products, Vallourec Group and Sumitomo Corporation for energy products and Allegheny Technologies (ATI), Carpenter Technology Corporation, and Haynes International (HAYN) for nickel-based alloys and super-alloys. [edit] Fastener Products segmentPCP Fastener operations compete with a large number of companies based primarily on technology, price, service, product quality and performance. Of these companies, Alcoa Inc. and Lisi SA are considered to be their leading competitors.
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