Description

1.  This submission will focus mainly on jets (which is 50% of TXT’s profit) but TXT has other businesses, too. Bell is another 25%, Industrial is 15% (plastic fuel systems + other T1-supply, and a golf cart, ATV, and plane-tug operation), and Textron Systems which is 10% (defense business that makes drones, landing crafts, engines, and operates some air force training classes). 

2.  Firstly, I think that this has the makings of a “good” company. 
   1.  Well managed, a strong balance sheet, and prudent capital allocation,
   2.  The company designs and assembles high-end, technological goods,
   3.  The industry is oligopolistic and it competes on quality & performance,
   4.  The total addressable market is at least stable, and may be growing,
   5.  The product is sticky (e.g., hard to downgrade form Dassault to Delta),
   6.  The stock trades in cycles, and we may develop a feel for the business

2.  I analyzed the Aviation business. TXT discloses 1) aircraft revenues, 2) parts revenues, and 3) units (Citation, KingAir, Caravan, and single-engine). I take reasonable guesses at the average price per King, Caravan, and single engine ($5-7m, $2-3m, $0.3m) and thus backed in to the average $ for Citation Jets. 
   
   It becomes evident that the Citation jet business is about 80%+ of revenues. In my analysis, I think it is most helpful to divide the business as: Citation Jet + all other planes + aftermarket.
   
   Between 2003 and 2010, TXT went through a major boom and bust. In the boom of ‘03–‘08, deliveries increased from 197 to 467. The price per Citation Jet (my guess) increased from ~$8 to ~$10m. In all, I guess that jet revenues ~tripled from $1.6bn to $4.6bn (huge) and revenues from the other planes  increased from $0.2bn to $0.4bn. The backlog swelled from $3.9bn to $14.5bn. Operating margins jumped from 8.7% to 16.0%. In 2009, the sun set. TXT saw $6.9bn of cancellations net of orders, delivered $2.7bn of airplanes, and the backlog shrunk to $4.9bn. By 2010, deliveries fell sharply to the pre-boom period and as operations de-levered, TXT generated margins of -1.1% in 2010. 

In the following years, the business went through an abnormally soft patch and margins did not approach the double digits until the 2018–2019 period. 

Due to weaker economic conditions in the post-GFC period (which, as you remember, lingered for a while abroad) and from the demand pull-forward from above average ‘05-‘08 deliveries (these ended up in the used market), the business for new airplanes was soft for ~6-8 years following the GFC. 

An important concept emerges. In the post-GFC period of decimation, the market may have over-tightened. The number of used Citations listed for sale held durably below the “average” level of ~12% since 2013 (and still now).

Further, since ‘16, deliveries have been <3% of fleet. I will guess that the PJ market should grow 1.5% p.a. in units (Bernstein estimates 2% is normal)[1]. Thus, deliveries to replace aging jets are only 1.0-1.5% of fleet. This is totally unsustainable because planes do not last for 70-100 years. This is key because if deliveries increase from 3% to 4.5% of fleet, that is a 50% swing.

Young planes flooded the market post-GFC, but the fleet aged significantly since. Planes older than 10 yrs. are now 70% of parc, vs. <50% in 2003.

There was a material up-swing in demand in the 1990s and into the GFC — and I think that some of these airplanes are getting old and will, in due time, "come home to roost". Thus, it is possible that the market for private airplanes will undergo a big replacement cycle over the next decade. 

Back to Textron:

Since Covid, orders for airplanes shot up and the backlog grew from <0.5 years to 1.5 – 2.0 years. Because TXT discloses its airplane backlog and its airplane revenues, I can guess at net orders/cancellations for the time periods (I assume that aftermarket/parts don’t contribute to the backlog figure). While orders increased in 2021 and 2022, orders in a more “normal” 2023 were still materially above the ‘15–‘19 avg. (and production did not increase).

Importantly, while TXT saw an increase in demand since ‘20, production has not ramped. Management argues that a 1-2 year backlog is normal and that the post-GFC period was unusually weak and abnormal. Further, a backlog allows for some pricing power. Overall, this has held the market very tight. 

Margins did not increase sharply as they have in the pre-GCF boom. This is due to 1) increased costs, 2) supply chain disruptions, and 3) below-normal production Management argues that present margins of 12% should increase further as TXT 1) captures price and 2) captures margin from higher volumes (incrementals for the next plane to “fly off the assembly line” are <25%).

In 2019, TXT delivered 206 Citations. Between 2020 — 2023, TXT produced an average of 161 Citations (sell-side guesses that 2024 will be ~180). Thus, there has been material under-production of jets since at least 2019. 

I believe that an argument can be made that normal Citation deliveries in 2026 should be materially higher than pre-Covid’s ~200 jets / year.

1.  The PJ depression of 2010–2016 overcorrected the excess supply of pre-GFC. Further, 2020–2024 production was below normal. Planes have become older than usual and there should be pent up demand.
2.  There was a boom in PJ demand during the dot-com bubble and these airplanes will need to be replaced beginning in 2025–2030. 
3.  There is more wealth in 2026 than in 2016, both in the West, and in the emerging world. (NA is about 70% of Citation demand.) 
4.  Population in 2026 should be at least 10% higher than population in e.g., 2016.
5.  Covid exposed more people to private air travel (for health and safety reasons) — and few will want to “downgrade” to commercial. 
6.  It seems than Cessna has gained market share. Bombardier is really struggling (it wanted to sell itself to Cessna in 2019).
7.  Cessna increased its TAM by expanding into slightly larger jets.
8.  I believe that the demand for long-haul, Gulfstream jets will be more hurt by digital/Zoom than short-haul, Citation flights.

Production in 2019 was 206 units and it averaged 161 in the four years since.

How far above normal will production be over the next 3-6 years given the above? My best guess for a 2026 rate is 230 (the Covid underproduction alone contributed a deficit of 155 units, plus the other 6 factors mentioned above). 

The math works out that if TXT presently generates 12% margins on 168 units, that it will generate 15%+ margins on 230 units (incrementals of 25%). 

I assume that prices are 25% higher in 2026 than in 2019 (3.3% CAGR, fair). Compared to 2019, 2026 units should be 15% higher (230 vs. 200) — thus, my best guess is that revenues should be 40% higher and margins should be 15%.

Given the above, my best estimate of earnings, if there really is a deficit of airplanes, is approximately $7.50 – $8.00 in 2026. What multiple should be used to value the company? Based on history and judgement, TXT deserves to trade at least at 18.0X EPS, which would mean a $140 stock in 2026. 

APPENDIX — OTHER NOTES

Use of Cash Flow

TXT’s generation (converted at 105%) and use of cash flow deserves an “A” grade. 

Between 2017 and 2023, Textron generated and used cash as follows:

Due to strong repurchases, Textron shrunk the average share count from 268.6m to 201.6m between 2017 and 2023 — a CAGR of (4.7%).

Catalyst

A generally tight market for airplanes which should lead to tight pricing and high volumes from deferred demand. Excluding the thesis, Textron appears to be an above average company and it trades at a below-average multiple of earnings.