by Barry Schwartz
At our shop, we are always on the hunt for a new investment idea. We try to research two new stock ideas a months. While we look at a lot of names, we rarely buy more than three or four new stocks a year. One stock that we purchased recently is Precision Castparts.
About six months ago I was looking at the 13F of Berkshire Hathaway. A 13F is the quarterly report that all investment companies must file with the SEC. It contains a list of all equities that the filing firm held at the end of a quarter. Looking at Berkshire’s list, I saw that it owned a small allocation of Precision Castparts. I took a mental note of it. Usually when one of us identifies an investment idea, we tell our analysts, Jeff and Ben, to add it to the list for review. In early December I was looking at a list of S&P 500 companies that were expected to show growing earnings but whose stock price was near a 52 week low. Wouldn’t you know it, Precision Castparts popped up again.
This time we put the pen to paper. Precision makes complex metal products for aircraft and industrial engines. Or as we like to say, it makes nuts and bolts. I don’t know if you have noticed but Boeing and Airbus are getting record orders for new aircraft. We always like to buy the racetrack, not the horse. With Precision, we don’t have to bet whether Boeing or Airbus will sell more planes, because Precision sells its parts to both. As airplanes become more complex, they require more parts, and Precision stands ready and waiting. If you are a purchasing manager at Boeing, I’d wager that you wouldn’t trust any old joe company with an order for a new nut or bolt. You’d probably go with the guy that’s been supplying you parts for decades, like Precision.
Recently Precision warned that its upcoming year would be tough due to a few delays, inventory restocking and slack orders for oil and gas products. As a result the stock is off close to 30% from its high. Some of these issues are temporary and solvable; and while oil product orders may take a while to come back, we think the market is missing the forest for the trees. In a recent presentation, Boeing predicted that 36,000 new aircraft will be needed over the next 20 years. That’s a lot of nuts and bolts! Precision’s runway of growth is massive. Meanwhile, the company generates healthy margins, a staggering amount of free cash flow and is trading off of depressed earnings levels. While I’ve never met the CEO, Mark Donegan, I’ve heard that all he cares about is cutting costs and I’ve seen his smart capital allocation in action. He doesn’t let one ounce of cash go to waste. This is one management team that cares deeply about shareholder value and if the company isn’t buying back stock, it’s looking to grow its product line by acquisition. The one knock on the stock is that it offers a paltry dividend. Get over it. There’s no need for a business with that much growth potential to start returning cash by way of dividends yet.
Precision fits the bill for us. Generous free cash flow, growing addressable market and good returns on equity and most importantly it is being offered at a reasonable valuation.