Woodward Inc. (WWD, Financial) is a relatively unknown mid-cap industrial company that creates energy control and optimization solutions.
The Fort Collins, Colorado-based company designs and manufactures control system solutions and components for the aerospace and industrial markets, such as fuel pumps, engine controls, actuators and air values. It operates in two segments – aerospace and industrial. The aerospace division provides systems and components that optimize the performance of fixed-wing and rotorcraft platforms in commercial, business and military aircraft, ground vehicles and other equipment. The industrial division provides systems and components that enhance the performance of energy-related industrial equipment. This includes fluid energy, combustion control, electrical energy and motion control systems that help customers offer cleaner, more reliable and more efficient equipment.
Woodward was founded in 1870 and currently has a market capitalization of $5.8 billion.
Growth strategy
Woodward expects future growth from the expansion of the aviation market worldwide as well the strong push for energy efficiency across most industrial companies. The company has produced steady financial results throughout most of its history and invests about 5% to 6% of revenue in research and development.
The company has somewhat of a competitive moat as the certifications required to operate in the highly regulated aviation business are often hard to achieve. This is also true in many of its regulated energy-related businesses.
On the aerospace side, about 40% of the revenue base is after-market support and services, which provide a beneficial recurring revenue base. Roughly half of the aerospace division is defense related, with the other half being commercial aircraft.
Financial review
On Aug. 1, the company reported third-quarter earnings for the period ended June 30. Total revenue increased 10%, while the aerospace segment recorded 18% growth, which was driven by higher aircraft production rates and increased air traffic. The industrial segment decreased 1%, driven by weakness in the China natura gas engine business.
Profitability was negatively affected by labor and material inflation as well as greater-than-expected global supply chain and labor disruptions. Operating income declined 13.4% to $58 million and net income declined 20% to $39 million.
Long-term goals
Woodward expects to generate strong organic growth from both divisions and produce segment margins of over 20% in aerospace and over 16% on the industrial side. Earnings per share growth is expected to be roughly twice the rate of sales growth on average.
Approximately 50% of net earnings are expected to be distributed to shareholders in the form of dividends or share repurchases. The remainder is expected to be used to strengthen the core business and look for tuck-in acquisitions. Woodward expects to continue to generate strong levels of free cash flow as it has historically.
Valuation
Consensus analyst estimates for the fiscal year ending September 2022 are $2.66 and $3.66 for the following year. That puts Woodward stock selling at 36 times this year's estimates. However, that number is unusually elevated due to the nearly unprecedented inflationary and supply chain issues the company is experiencing.
The company pays an annualized dividend of 76 cents, which equates to a below-market-average dividend yield of 0.78%. The company has chosen to utilize a large portion of free cash flow to repurchase shares, which totaled $440 million for the nine-month period ended June 30.
Guru trades
Gurus who have purchased Woodward stock recently include Chuck Royce (Trades, Portfolio) and Caxton Associates (Trades, Portfolio). Gurus who have sold or reduced their positions include Mario Gabelli (Trades, Portfolio) and Jim Simons (Trades, Portfolio)' Renaissance Technologies.
Conclusion
Woodward is a high-quality, well managed company that is currently not earning up to its true potential. Over time, the company has the potential to produce strong double-digit earnings growth due to its end market targets. Also, with a market cap of only $5.8 billion, the company would make a prime acquisition candidate by larger industrial players.
