RTN, BA, 3M, CAT Industry Analysis
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This document analyzes four major industrial companies - Raytheon, Boeing, 3M, and Caterpillar. It identifies common risks across the industry like economic conditions, government policies, foreign exchange rates. It also outlines firm-specific risks for each company. The document then discusses how each company manages risks, like diversifying sales, hedging foreign exchange, and monitoring contract performance. It analyzes the optimal capital structure for each firm based on their cost of debt and equity. While Raytheon and Boeing maintain low debt ratios given their large scale, 3M and Caterpillar's capital structures may gradually change due to their different cost of capital profiles.
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RTN, BA, 3M, CAT Industry Analysis
- 1. Industrial Industry Analysis Applied Corporate Finance April 11, 2013 Gangming Liang
- 2. Agenda P-‐01 Raytheon, Boeing, 3M, Caterpillar • Past Performance • Identified Common & Firm Specific Risks • Risks Management Strategies • Capital Structure • Investment Consideration & Recommendation
- 3. IntroducAon & Performance P-‐02
- 4. Common Industry Risks P-‐03 • General Economic Situation (Customer Demand) : All Companies • US or Non-US Government Budget & Policies: Defense (Raytheon & Boeing), Infra (CAT) • Foreign Exchange Fluctuation : All companies • Products & services Less-Diversification: Raytheon (Military), Boeing (Aircraft), CAT (Construction), Except 3M • Other Common Risks: Commodity Price Fluctuation, International Law Environment, Credit Rating, Product Innovation, Competition, Taxation, etc.
- 5. Common Industry Risks P-‐04 RTN 1) Deep Relation with Defense Budget (73% of US) 2) Fixed Price OF Contracts 3) Some Financial Ratio Problems BA 1) Dependency on U.S. Gov. Sales (Defense Budget) 2) Commercial Aircraft Industry Competition 3) Reputation (787 Engine Issue) 3M 1) High % of International sales (2/3) 2) Acceptance of New Products 3) Dependency on Other Industries CAT 1) CAT Financial Subsidiary Risks 2) Component Price (ex, Steel) 3) Dependency on Energy & Mining
- 6. Risk Management Strategies P-‐05 Raytheon (RTN) Domestic & International Sales • Department of Defense (DoD) Priorities • Over 15,000 Contracts • Diverse Portfolio of Programs • International customers continue to adopt Defense Modernization • Leverage on Knowledge • Innovative supply chain solutions • Deliver innovative supply chain solutions Fixed price Contract • Wide Standard Disciplined Quarterly • Estimate at Completion (EAC) Process • Management Reviews Progress & Performance of Contracts • Key Contract Matters • Progress to Completion • Risks & Opportunities • Estimate Revenues & Cost • Quarterly Adjustment to Net Sales
- 7. Risk Management Strategies P-‐06 Boeing (BA) Commercial Airline Industries • International Competitors • Airbus, Russia, China, Japan • Improve Process & Cost Reduction • Customer Support Services Network • Aviation Support • Spares • Training • Maintenance Document • Resulted Customer Satisfaction & Pricing Strategies 787 Program • Newest Boeing program • Battery Failure • Production continues & increase production rate • Improving production system • Coordinate with suppliers • Increase production rate in final assembly
- 8. Risk Management Strategies P-‐07 3M (MMM) Market Risks: • Foreign Exchange Rates • Interest Rates • Commodity prices • Value at Risk Foreign Exchange Rate • Forward & Option Contracts to Hedge Exchange Rates • Cross Currency Swaps & Forwards to Hedge Net Foreign Investments Interest Rates • Fixed & Floating Rate Debt for Interest Expenses • Interest Rate Swaps to Manage Borrowing Costs Commodity Prices • Negotiated Supply Contracts • Price Protection Agreements • Forward Physical Contracts Value at Risk • Monte Carlo Simulation
- 9. Risk Management Strategies P-‐08 Caterpillar (CAT) Credit Quality of Finance Receivables • Review on Monthly Basi • Performing & Non- Performing Interest Rate & Foreign Exchange Sensitivity • Foreign Currency Forward & Option Contract • Interest Rate Swap • Forward Rate Agreement
- 10. OpAmal Capital Structure P-‐09 All Companies Keep Similar Capital Structure With Their Optimal Capital Structure Assumptions • Calculate Corporate Values by Indirect Method • Downgrade One S&P Rating with each 10% Increase of D/ A Ratio • Increase Yield Spreads with each 10% Increase of D/A Ratio Yield Spreads Over 10- Y Treasury Bonds by Bond Ratings (Basis Points) AAA AA A BAA BA B CAA Yield Spread 58 71 92 147 410 610 955 Source: Graham R & Smart (2011). Introduction to Corporate Finance. Cengage Learning Table 4-3. The Relationship Between Bond Ratings and Spreads at 10 year Maturity in Basis Points on page 138 Raytheon Boeing 3M Caterpillar (Billions) Current Optimal Current Optimal Current Optimal Current Optimal Debt: Equity 20.2:79.8 30:70 16:84 20:80 9.8:90.2 0:100 39.4:60.6 40:60 Corporate Value 23.4 23.4 67.3 68.3 70.3 72.3 96.8 96.9 WACC 9.1% 9.1% 9.2% 9.1% 8.2% 8.0% 10.0% 9.9%
- 11. OpAmal Capital Structure P-‐10 In Spite of Large-‐ Scale Businesses, RTN & BA Keep Low D/A RaAos However, Future Uncertainty may Affect Capital Structures Raytheon • Long- Term & Large Scale Production • Slightly Higher D/A Ratio than Boeing because of Lowest Beta • Uncertainty of Gov. Policy May Causes Capital Structure Reorganization Raytheon Boeing (Billions) Current Optimal Current Optimal Debt: Equity 20.2:79.8 30:70 16:84 20:80 Corporate value 23.44 23.45 67.4 68.3 Debt Value 4.7 7.0 10.8 13.7 Equity Value (Mkt) 18.7 16.5 56.6 54.6 WACC 9.1% 9.1% 9.2% 9.1% Cost of Debt After- Tax 4.7% 5.1% 4.8% 4.8% Cost of Capital 10.2% 10.7% 10.1% 10.2% Levered Beta 1.13 1.25 1.11 1.13 Boeing • Long- Term & Large Scale Production • Low D/A Ratio Due to Advance Received • 787 Problems May Change Current Capital Structure
- 12. OpAmal Capital Structure P-‐11 Different Cost of Debt & Capital Cause Different Capital Structures 3M & CAT Could Change Their Capital Structures Gradually 3M • High Cost of Debt: Low Liquidity & Low Effective Tax Rate • Low Cost of Capital: Low Beta Due to Diversified Business (Using More Equity Maximize Value) • Could Change Capital Structure Slowly 3M Catapiller (Billions) Current Optimal Current Optimal Debt: Equity 9.8:90.2 0:100 39.4:60.6 40:60 Corporate Value 70.3 72.3 96.8 96.9 Debt Value 6.9 0 38.1 38.8 Equity Value (Mkt) 63.4 72.3 58.7 58.1 WACC 8.2% 8.0% 10.0% 9.9% Cost of Debt After- Tax 5.3% 0.0% 3.8% 3.8% Cost of Capital 8.6% 8.0% 13.9% 14.0% Levered Beta 1.07 0.96 2.15 2.17 Catapiller • Low Cost of Debt • High Cost of Capital: High Beta Due to Less-Diversified Business (Using More Debts Maximize Value) • Could Change Capital Structure Slowly (e.g. Project/ Capex Financing)
- 14. The End QuesAons April 11, 2013 Gangming Liang