Rockwell Collins (COL)

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The performance of Rockwell Collins' government sector is largely dependent on the allocation of the U.S. defense budget. U.S. government sales comprised 36% of total COL sales in FY 07, and COL continues to invest heavily in the research and development of new products in order to obtain future government contracts. ^[2] COL's business is also susceptible to the cyclicality of the aerospace industry, and COL's commercial sector is tied to the fortunes of commercial airlines'. In order to capitalize on perceived market opportunities, in FY 2008, COL has begun investing more in data systems for business jet customers (i.e. e-mail and broadcast TV), which it believes will generate higher returns on investment than in-flight entertainments systems for wide body jets.

[edit] Company Overview

^[3]

Since 1997 COL has acquired a number of complementary companies in order to bolster its government and commercial businesses, including five acquisitions in the past three years. ^[4]

[edit] Business and Financial Metrics

Rockwell Collins' sales have grown at an average of 12% annually over the past five years, with projections of between $4.7 and $4.75 billion for FY 2008. ^[5] Over the same time period, the company has increased return on invested capital each year -- 33% in 2007 -- and converted an average of 126% of their profit after tax into operating cash flow. ^[6]

In FY 2007, strong market conditions coupled with market share gains in both the Commercial and Government sectors and the strategic acquisition of Evans & Sutherland Computer (ESCC) let COL meet or surpass three key annual performance targets. The company logged sales growth of 14% for the year, 4% above target, and an operating cash flow of $607 million (104% of net income), falling within the target range of 100% - 130%. Additionally, earnings per share growth of 26% drastically surpassed their goal range of 13% - 15%. ^[7]

^[8]

While domestic sales continue to account for the majority of Rockwell Collins' revenues, their international presence in 2007 did demonstrate growth, recording an increase of 14.5% in foreign sales. ^[9] The company also increased investment in research and development 15%, or $105 million, to $827 million. ^[10]

Through Q3 2008, total sales have increased 9.5% from Q3 2007 to $3.492 billion, and net income has grown 15% to $496 million. ^[11] Over the course of FY 2008, COL projects research and development expenditures to fall within the range of $925 million to $950 million and earnings per share growth to reach between $3.80 and $3.95. ^[12]

[edit] Business Segments

Rockwell Collins operates two main business segments.

• Government Systems (49.5% of Revenue, 46% of Operating Income)^[13]: The government systems segment encompasses COL's dealings with government agencies, civil agencies, defense contractors, and foreign ministries. Through Q3 2008, the division contributed 49.5% of total sales and 21% operating margins.^[14] Furthermore, operating earnings increased 13% to $361 million over YTD earnings in FY 2007. ^[15]

• Commercial Systems (50.5% of Revenue, 54% of Operating Income)^[16]: The commercial systems division provides aviation electronics and services to businesses worldwide. Customers include original equipment manufacturers of commercial air transport, businesses and regional aircraft, and commercial airlines. ^[17] Through Q3 2008, the division contributed 50.5% of total sales and 24% operating margins.^[18] In addition, operating earnings increased 17% to $416 million.^[19]

[edit] Trends and Forces

[edit] Overall health of the commercial airline industry impacts COL's business

Demand for Rockwell Collins' Commercial Systems products is largely determined by the commercial airlines industry.^[21] Although the Government Systems segment reduces COL's exposure to market volatility, the seasonal and cyclical nature of the air travel industry still causes periodic downturns and upturns in COL's business, and extraordinary circumstances like 9/11 or the SARS outbreak negatively impact both airlines and manufacturers like Rockwell Collins.

As of Q3 2008, however, the division has weathered the 2008 crisis facing air travel as a result of a spike in oil prices fairly well: commercial sales through Q3 of 2008 are up nearly 12%, or $183 million, from Q3 2007, and operating earnings have increased 17%, or $61 million, from Q3 of last year.^[22]

[edit] Rising fuel costs reduce airline purchasing power

Fuel costs account for a large part of airline operating budgets. Elevating fuel prices increase costs and reduce profits for airline companies, who may cut down on airplane orders to make ends meet. Furthermore, because a large portion of COL's commercial products are discretionary, airlines may prefer to pass on such goods when times are tough. At the same time, fuel pricing pressure has also increased demand for fuel-efficient aircrafts, a trend which Rockwell Collins hopes will generate additional work contracts as more fuel efficient airplanes are produced.

[edit] International conflicts and terrorism cause negative repercussions for COL

Uncertainty pertaining to business markets in the US and abroad caused by terrorist attacks and conflicts like the Iraq War adversely affect Rockwell Collins. In fact, international conflicts result in reduced aircraft build rates, decreased demand for upgrades, as well as smaller expenditures on discretionary products like in-flight entertainment. ^[23] While the Government Systems division may benefit in such circumstances from increased government defense spending, foreign conflicts and terrorist attacks often increase the price of oil, and raise the cost of property and aviation products insurance, both of which raise COL's costs of production.^[24]

[edit] Dependence on U.S. government contracts expose Rockwell Collins to unique risks

In FY 2007, 36% of Rockwell Collins' sales were generated from U.S. government contracts.^[25] Indeed, Rockwell Collins' revenues are largely dependent on the US Department of Defense's budget spending, and on their ability to win new contracts. As a result, COL is exposed to a number of risks beyond their control. The U.S. government, for example, is able to terminate without prior notice partially completed government programs and contracts that were previously authorized. ^[26] Additionally, changes in legislation or political policies regarding military developments often affect the availability of government business. The Department of Defense's budget varies according to perceived threat to the US, and reduced levels of global threat usually require less defense spending.

[edit] Competition

Rockwell Collins operates in an international landscape and faces domestic and foreign competition. Due to its high barriers of entry, the market for commercial cockpit controls is dominated by Rockwell Collins, Honeywell International (HON), and Thales.^[27] The in-flight entertainment industry is similarly concentrated, with COL and Japan's Matsushita Electric Industrial Company (MC) each controlling 50% of market share.^[28]Finally, COL's Government Systems division competes primarily with Raytheon Company (RTN).^[29]

To a lesser degree, Rockwell Collins also competes with the following companies: Panasonic, Harris (HRS), BAE Systems (BAESY), General Dynamics Corporation, L-3 Communications Holdings (LLL), Boeing Company (BA), and Northrop Grumman (NOC). ^[30]

For the relevant aerospace industries, annual change in available cash is noteworthy because it illuminates the available capital a company has for research and development. Rockwell Collins is a relatively small company, and thus has less available capital than its larger competitors for such expenditures.

[edit] References

1. ↑ Rockwell Collins, Inc. Morningstar Analyst Report, page 2, May 9, 2007
2. ↑ Rockwell Collins S&P Stock Report, page 2, August 25, 2008
3. ↑ Google Finance
4. ↑ COL 2007 10-K, Item 1: Business, page 9
5. ↑ Rockwell Collins 2007 Annual Report, page 15
6. ↑ Rockwell Collins 2007 Annual Report, page 1
7. ↑ Rockwell Collins 2007 Annual Report, page 15
8. ↑ Rockwell Collins 2007 Annual Report, page 15
9. ↑ Rockwell Collins 2007 Annual Report, page 15
10. ↑ Rockwell Collins 2007 Annual Report, page 17
11. ↑ COL 2008 10-Q, Item 1: Condensed Consolidated Financial Statements, page 3
12. ↑ Rockwell Collins 2007 Annual Report, page 15
13. ↑ COL 2008 10-Q, Item 20: Business Segment Information, page 16
14. ↑ COL 2008 10-Q, Item 20: Business Segment Information, page 16
15. ↑ COL 2008 10-Q, Item 20: Business Segment Information, page 16
16. ↑ COL 2008 10-Q, Item 20: Business Segment Information, page 16
17. ↑ Rockwell Collins 2007 Annual Report, page 20
18. ↑ COL 2008 10-Q, Item 20: Business Segment Information, page 16
19. ↑ COL 2008 10-Q, Item 20: Business Segment Information, page 16
20. ↑ COL 2008 10-Q, Item 20: Business Segment Information, page 16
21. ↑ COL 2007 10-K, Item 1A: Risk Factors, page 13
22. ↑ COL 2008 10-Q, Item 20: Business Segment Information, page 17
23. ↑ COL 2007 10-K, Item 1A: Risk Factors, page 12
24. ↑ COL 2007 10-K, Item 1A: Risk Factors, page 12
25. ↑ COL 2007 10-K, Item 1A: Risk Factors, page 12
26. ↑ COL 2007 10-K, Item 1A: Risk Factors, page 12
27. ↑ Rockwell Collins S&P Stock Report, page 2, August 25, 2008
28. ↑ Rockwell Collins S&P Stock Report, page 2, August 25, 2008
29. ↑ Rockwell Collins S&P Stock Report, page 2, August 25, 2008
30. ↑ COL 2007 10-K, Item 1: Business, page 7
31. ↑ Google Finance
32. ↑ Google Finance
33. ↑ Google Finance
34. ↑ Google Finance
35. ↑ Google Finance