Woodward: Upgrade Warranted After Costly Miscalculation (NASDAQ:WWD)

One of the downsides to value investing is that it can be difficult to give bullish ratings to companies that are growing fairly quickly due to the price at which the stock is trading. Ingrained in our minds is the idea of buy companies at a low price. Therefore, high trading multiples can sometimes hinder that. An example of this that I could point to is a company called wood (NASDAQ: World Water Day). For those unfamiliar with the company, it operates as a designer and producer of control solutions for the aerospace and industrial markets. The company has a wide range of products. But some examples of his work include building innovative fluid power, combustion control, electrical power and motion control systems that help with the efficient operation of equipment.

The last article that My writing about the company was published in early May 2023. At that time, I was still impressed by the strong sales and cash flow growth the company was achieving. The company continued to exceed even the expectations that analysts had placed on it. However, I couldn't get over how expensive the units were. Despite recognizing the company as a high-quality operator, I couldn't give it a rating higher than “hold.” Unfortunately, those who followed that thought process missed some significant developments. Since the publication of that article, the S&P 500 has generated a rise of 26.1%. In comparison, Woodward has seen an increase of 39.4%.

You'd think that given how much the stock has risen, I'd be even less forgiving this time around. However, I would like to think that I have learned from my mistakes. Interestingly, the forward estimates I provided to the company at the time covered fiscal year 2023. Today, they cover fiscal year 2024. And even though the stock has soared, the stock is actually cheaper today using both the price to earnings approach and the EV to EBITDA approach, which back then. With management and the company dedicated to returning capital to shareholders forecasting further growth, I believe a soft “buy” rating is appropriate at this time.

A change of tone

Operationally, things have been going very well for Woodward and his investors. Consider, for example, how the company performed during its fiscal year 2023. Revenue during that period was $2.91 billion. This represents a staggering 22.3% increase compared to the $2.38 billion generated in 2022. This growth came from the companies' two operating segments. The aerospace segment, for example, saw revenue growth of 16.4%, from $1.52 billion to $1.77 billion. Increased volume driven by strong demand for the company's products and services resulted in $144.3 million of increased sales for this segment. However, industrial operations fared even better, with revenue soaring 32.8%, from $863.5 million to $1.15 billion. The increased volume associated with this segment contributed $249.7 million of the increased sales the company enjoyed. While non-monetary considerations and foreign currency fluctuations had a negative impact on the business, price increases in both segments had a combined positive impact of $181.1 million.

With revenues rising, and some of that growth driven by higher prices, management has also managed to boost its bottom line. Net income, for example, increased from $171.7 million in 2022 to $232.4 million last year. Other profitability metrics followed a similar trajectory. Operating cash flow expanded from $193.6 million to $308.5 million. If we adjust for changes in working capital, we get a more modest increase from $287.4 million to $336.8 million. And as far as EBITDA goes, we get an increase from $356.1 million to $475.5 million.

Fiscal year 2023 wasn't just a blip on the radar. The company's growth continued into the early parts of the year. 2024. Driven by growth in both segments, revenue in the first quarter of 2024 amounted to $786.7 million. That's 27.2% above the $618.6 million generated a year earlier. Higher prices once again contributed to this advantage, to the tune of $49.8 million. But industrial volume accounted for $79.2 million in sales, while aerospace volume was responsible for $34.5 million. The company appears to be benefiting not only from rising aircraft utilization rates (there has been growth in both domestic and international passenger travel) but also from its natural gas truck operations on China's highways.

Revenue growth has had a really positive impact on profitability. Net income of $90 million eclipsed the $29.6 million generated during the same period in fiscal 2023. Operating cash flow soared from $5.4 million to $46.8 million. If we adjust for changes in working capital, we get an increase from $70.3 million to $123.8 million. And finally, the company's EBITDA managed to grow from $71.8 million to $147.9 million.

What's really exciting is that management has raised its growth expectations for this year. By 2024 in its entirety, now anticipate revenues of between $3.15 billion and $3.3 billion. At the midpoint, that would be 10.6% above what was generated in 2023. If we take the midpoint of the guidance provided by management, we should be looking at net income of about $322.4 million, a cash flow of operating cash of approximately $425 million and an EBITDA that amounts to approximately 600 million dollars.

With these results, valuing the company becomes very simple. In the chart above, you can see exactly what I mean. In absolute terms, I would say the stock is definitely not cheap. In most cases, I would consider this to be slightly overvalued using 2023 results and quite overvalued going forward. But as you can see, the growth continues to impress. In cases like this, a premium is often justified. But it's not just that. The shares are also attractively priced compared to similar companies, as you can see in the table below. In that table, I compared Woodward to five similar companies. Unfortunately, four of the five ended up being cheaper when it came to the price-to-operating cash flow approach. But this number falls to two of the five that use the price-earnings approach, and just one of the five that use the EV-EBITDA approach.

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In addition to being attractively priced compared to similar companies, management is also returning capital to shareholders. While I would prefer they focus on additional growth, the outlook could be worse. You see, during fiscal 2023, management allocated $126.4 million for share buybacks. And on January 25, they Announced a new share buyback program worth $600 million. This replaced the old $800 million stock buyback program that allowed the company to buy back $572 million in stock over the past two years. In addition to this, management also decided to increase the quarterly distribution by 14% from $0.22 per share to $0.25 per share. This isn't much in the grand scheme of things, but the return of capital to shareholders is often viewed in a positive light, no matter how small it may be.

Carry

From what I can tell, Woodward has proven to be a high quality company. The company has achieved rapid growth in a competitive market. The shares are expensive, but affordable compared to similar companies. ohOn top of this, the expectation of additional growth this year, as well as the company's track record of returning capital to shareholders, leads me to believe that I have been too pessimistic about the business all this time. Because of this, I have decided to upgrade the stock from a “hold” to a soft “buy” to reflect my view that the stock is likely to outperform the broader market for the foreseeable future.