Catch This One After the Tumble

 | Apr 22, 2013 | 10:00 AM EDT  | Comments
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Textron (TXT) was the worst performer in the S&P 500 last week, down 11.6%. I think it's a buy.

Shares of the Providence, R.I., conglomerate closed Friday at about $26, only $1 above their year-end 2003 level. What's wrong? The answer can be summed up in two words: "conglomerate" and "defense."

When I entered the financial world in the early 1970s, conglomerate companies were all the rage, with Harold Geneen's ITT Corp. the exemplar and pinnacle. Good management teams, it was thought, could shape up a variety of businesses and make them run better.

Today, the thinking is the opposite. Companies should specialize and stick to their knitting, investors think today. My view is that both sides are wrong. In my opinion, it is the skill and charisma of management, not corporate format, that determine success or failure.

Textron's sizeable defense business -- about one-third of revenue -- is also seen as an albatross today. The federal government is under enormous pressure from the Tea Party and from ordinary voters to reduce the budget deficit. Defense is close to one-fifth of the budget, and cutting it will provoke fewer howls of protest than reductions in Social Security or Medicare.

I like Textron shares even though I expect most of the "sequester" budget cuts in the defense budget to stick, and for additional cuts to be made over the next two years.

Textron's defense businesses (Bell helicopters, Commando tanks, and Shadow drones) will be affected, no doubt. But I think Textron will suffer less than some competitors because it is in some of the better segments within the defense industry.

Let's not forget that the majority of Textron's revenue is not tied to defense. Bell Helicopter is a leading provider of civilian helicopters as well as military ones. According to the company, about one-third of all helicopters now in use in the world are Bell products.

Cessna, the civilian small-plane unit of Textron, accounts for 25% of revenue. The big drop in the stock last week happened after CEO Scott Donnelly lowered the company's estimate on Cessna sales this year. But in my view, this unit is likely to benefit from an improving U.S. economy over the next year or two.

Textron also has an industrial segment that makes a variety of products, from golf carts to windshield washing systems. It has been showing fatter profit margins of late.

Over the past 10 years, Textron shares have sold for an average of 20x earnings. Today they sell for only a 13x multiple.

The price-to-revenue ratio is also favorable. It's at 0.6, which is below Textron's historical average of 0.73, and way below the 1.4 average on the S&P 500.

Textron stock dropped 17% the day Donnelly lowered his Cessna forecast. The next day, J.P. Morgan analyst Joseph Nadol upgraded the stock to a buy. I think he has the right idea.

John Dorfman is chairman of Thunderstorm Capital LLC, a money management firm in Boston. He can be reached at jdorfman@thunderstormcapital.com.

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