Woodward reaps fruits from investment in new products

Woodward Governor Co. (Nasdaq: WGOV) posted record sales in its latest fiscal year, breaking through the $800 million barrier and achieving 17 percent growth, the kind of button-busting numbers reminiscent of Silicon Valley in the late 1990s.

It seems the logical question for Woodward CEO Tom Gendron is when does he expect to be a $1 billion company.

Gendron’s already looking beyond that.

“One billion is pretty close. What we really are talking about is ‘What about $2 billion?'” Gendron, 44, said during an interview in his Fort Collins office. “What we’re trying to do is hire and develop our leaders and put in systems and a structure to run a $2 billion company.”

The kind of growth envisioned by Gendron, who rose through Woodward’s management ranks to become CEO earlier this year, would appear to be a matter of staying the course.

After all, Woodward has more than tripled its business since 1990, when it was a $286 million operation. Still, the growth has come in fits and starts, including near-crisis conditions in the mid 1990s and again in 2002-03.

Even with the surging growth of 2005, the company was simultaneously ironing out wrinkles in its European operations – Woodward announced the closure of plants in The Netherlands and England – that were a drag on operating margins.

It’s easy to be optimistic, however, when you have a “golden balance sheet,” according to Gendron.

“We are essentially debt free; we have more cash than debt,” he said. “We have the wherewithal to do a lot of things.”

That includes growth by acquisition, as well as increasing investment in research and development. Last year Woodward jacked up its R&D spending by 25 percent to $50 million. “It’s going to go up again this year, mainly because we’re working on so many programs (contracts),” Gendron said.

The company has positioned itself as the primary supplier of fuel control products for the engines going into Boeing’s new 787 and the Airbus A350. And with new plane orders on the rise, Woodward stands to reap more rewards.

The acquisition opportunities are also promising, said Tyler Hojo, a securities analyst who follows Woodward for Sidoti & Co.

Industrial controls, which represents a majority of Woodward sales, is highly fragmented as an industry. “They (Woodward) currently have about 20 percent of the market,” Hojo said. “There’s a lot of freedom there to acquire.”

Evolutionary process

Woodward Governor Co., founded in Rockford, Ill., in 1870, has evolved from its earliest days as a maker of waterwheel governors to develop control systems for diesel engines, propellers, jet engines and nuclear power plants.

The company maintains its headquarters and aircraft controls division in Rockford. The Fort Collins operation, which is the center of Woodward’s industrial controls division, was established in the 1950s. The Loveland plant opened in 1993. The two sites employ about 1,000 full-time workers, a number that’s increased from about 800 two years ago.

The company maintains international sites in Australia, Brazil, China, Germany, India and Japan, and employs about 3,600 full-time staff worldwide.

Woodward’s resounding success in 2005 is due in large part to its decision to reinvent itself during the 1990s.

On the product front, the company’s core aircraft controls business “was dying” in the early 1990s, Gendron said. Beginning in 1994 the company revamped its entire line of aircraft controls, which led to its successful program wins for both the Boeing and Airbus engines.

“In 1994 we were almost out of the wide-body market,” Gendron said. “Ten years from now we’re going to be in almost every modern wide-body out there,” Gendron said.

The industrial controls division didn’t face the same dire circumstances, but it managed to enter new markets that became critical to its growth.

Prior to 1999, the company had “almost zero sales” in combustion products for large industrial plants. “Today that’s probably 20 percent of our business,” Gendron said.

Demand for large gas-powered turbines helped Woodward surge between 1999 and 2001, when construction of new power plants was rampant. But then the power market collapsed and Woodward’s sales went flat during 2003, when the company was forced to lay off workers.

In 2005, the return of the power market was a key factor in Woodward’s resurgence. Most importantly, Woodward’s customers around the world are dealing with tighter emissions regulations, which call for new engine systems.

Some of that environmentally driven business is likely to continue. For instance, China has set a goal of 2010 to meet European emission standards with its power plants, Gendron said.

In the short term, Woodward has set modest expectations for 2006 – the company’s fiscal year runs Oct. 1 and Sept. 30. Its guidance for the current fiscal year is for no more than 6 percent growth with greater expectations in 2007, when some of its aviation contracts will start to kick in.

Securities analysts who follow Woodward are largely optimistic about what they see. Especially Sidoti’s Hojo, who recently adjusted Woodward’s investment rating to “buy” from “neutral,” and set a 12-month price target for the stock at $101. It was $83.55 as of Dec. 5.

Hojo is particularly positive about Woodward’s operating margins on the industrial controls side, which could grow to 10 percent this year after just 3 percent in the last fiscal year.

Woodward also stands to be more active on Wall Street in the coming year. Pending shareholder approval, the company wants to execute a three-for-one stock split in January.

“That means more people can afford it, and that means more volume,” Hojo said.

Consequently, that means a more liquid stock and possibly more interest from investment funds, although Hojo doesn’t feel it should affect Woodward’s investment value.

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