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)

13. Conclusion
P-­‐01

14. The
End
QuesAons
April
11,
2013
Gangming
Liang