Tuesday, September 1, 2009

Textron Inc. (NYSE:TXT): Upgraded at Morgan Stanley, Could Be a Two Year Double

Plenty of calls today with my favourite one coming from Morgan Stanley:

We are upgrading Textron to Overweight from Underweight with an 18-month price target of $25. While there is an above-average risk in this “double upgrade,” we believe that the risk-reward outlook for TXT is compelling. This is principally because our assessment of the prospects/value of Textron Finance (TFC), based on a differentiated and detailed analysis, is more favorable than the market’s. If we are right, TXT could be a two year double.

Where we differ: Textron Finance undoubtedly faces significant issues. However, equity and convertible capital raise, coupled with stronger-than-expected cash flow in 2Q, has significantly reduced the risk of a liquidity-driven bear case at TFC and therefore TXT. Most importantly, we believe that TXT excluding TFC should trade at approximately 12-13X 2011e EPS, implying a current negative TFC value of ~$5–7/share. This level of negative value would imply total writedowns of ~35%–45%, and ~50%–65% of the non-aircraft portfolio. In contrast, our bottoms-up analysis indicates likely write-offs of 24% in our base case. Notably, excluding TFC losses, TXT currently trades at only 9X 2011 EPS.

We now see a “middle-ground”: Our prior underweight rating was based on the potential of an extremely stressed “bear” case outcome at TFC/TXT. We now believe that TFC will track towards a “middle ground” with substantial but manageable write-offs (aided by ongoing cash flows from much of the finance).

Cessna would be “icing on the cake”. Of secondary importance, we see growing evidence that the business jet market may be nearing a trough, and we anticipate a recovery after 2010.

Action: Plenty of reasons to like this call. Double upgrade (from Under to Over) that makes sense from Tier-1 firm, volatile stock, even the futures seem to be recovering. Would expect to see 7-10% upside today, meaning anything below $16 is a buy.

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