Textron Earnings: Here's the 1 Number That Matters Most

By Rich Smith Markets Fool.com

Yesterday's news that Textron (NYSE: TXT) has agreed to buy out all-terrain-vehicle-maker Arctic Cat (NASDAQ: ACAT) made a lot of headlines. But did you know that Textron had some other news to report, too?

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Oh, nothing much -- just its full-year financials for fiscal 2016. Here's how those went.

Textron let two cats out of the bag this week -- an acquisition, and earnings. Image source: Getty Images.

The news

We'll be bringing you a detailed analysis of the Textron-Arctic Cat combination shortly. For today, let's focus on what Textron had to say about its earnings for last year. For fiscal 2016, Textron reported:

  • 3% sales growth to $13.8 billion
  • 4% growth in operating profits ($1.3 billion)
  • A 20-basis-point improvement in operating profit margins (now 9.5%)
  • A huge, 41% bump in net income -- $3.53 per diluted share.

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How'd they do that?

That last line is pretty impressive. So how did Textron turn a modest 3% increase in sales, and a minuscule improvement in profit margins, into such a huge increase in profits?

The answer comes in two parts. For one thing, Textron's results in 2015 were burdened by $123 million in one-time charges to earnings. Simply removing this weight from the company's results allowed Textron's earnings to rise substantially in 2016. Additionally, Textron took a much lighter tax hit in 2016 than it incurred in 2015, which allowed a further $240 million to fall to the bottom line. Between these two factors, Textron was able to report a pretty good year for fiscal 2016.

Looking forward

But what about 2017? What should we expect from the year ahead? Well, Textron issued new guidance on that front this week, telling investors to expect slightly better revenue growth -- up 4% year over year to $14.3 billion. Unfortunately, even this modest good news on revenue may be outweighed by a rather steep decline in earnings.

Textron is projecting GAAP profits of $2.40 to $2.65 per share this year. Taken at the midpoint, and weighed against the stock's current $48 share price, that works out to a P/E ratio of about 19.4 -- which seems kind of steep for a company that by its own admission is only growing sales at 3% or 4%, and not growing earnings at all.

One number to watch...

The one bright note contained in Textron's guidance concerns free cash flow -- and if there's any reason to hope to see Textron's share price go up this year, it probably lies here. You see, Textron's cash flow statement shows that in fiscal 2016, the company generated only $568 million in free cash flow (cash from operations, minus capital expenditures). That number was down 16% year over year -- and even further below the company's reported "net income" for the year.

In 2017, however, management is promising to produce anywhere from $650 million to $750 million of what it calls "manufacturing cash flow before pension contributions" -- a metric Textron created in-house, but one that roughly corresponds to the standard definition of free cash flow. While we can't be as exact on this one, the midpoint of that guidance range does appear to indicate that Textron is looking to grow its cash profits this year, and perhaps even grow them at a rate faster than it grows sales -- which would be a good thing.

...and one thing to be wary of

That said, Textron is issuing all of this guidance subject to update if and when its purchase of Arctic Cat goes through. The problem is, data from S&P Global Market Intelligence indicate that adding Arctic Cat's negative GAAP profits to Textron's income statement, and Arctic Cat's negative free cash flow to Textron's cash flow statement, are more likely to make Textron's situation worse, not better.

When you get right down to it, I fear that even Textron's got a rocky road ahead of it in 2017.

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Rich Smith has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.