A Tribute to Veterans: Invest in Aerospace and Defense

Happy Veterans Day to all. Today the end of World War I, and celebrates peace and heroism among servicemen and civilians alike. While almost a quarter of the working population is observing the holiday, certain companies never stop working because of the nature of the work. One such industry is the aerospace and defense industry.

Protecting the interests of entire nations and cultures is of the utmost importance to most countries' governments, and the aerospace and defense industry is one of the premier outlets for this protection. One small-cap company that may or may not be an interesting investment for investors is Ducomunn Inc DCO.

Ducomunn designs and manufactures components for various aerospace companies and provides an array of advisory solutions to its clients. As expected, Ducomunn would fall in the category of companies that continues to work hard on a day like today. Despite the nature of the business, is Ducomunn a prudent investment in uncertain economic times?

From an operational perspective Ducomunn has been progressively growing quarter over quarter. Revenues have been growing over the last five quarters: in Q3 2010, revenues were $99 million, and in Q3 2011, revenues were $185 million. Along with revenue growth, the company has managed to control the growth of operating expenses, increasing operation margins. The interesting thing is that net income has not been growing at the same rate. The prime line item that seems to be holding it back appears to be interest expense. this may mean that the company is tapping the capital markets to keep the business afloat.

When looking at the actual flow of cash, in and out of the company, the situation seems to be different. While net income along with depreciation and amortization bolster operational cash flow, working capital has been dragging cash to negative numbers. The biggest line item in this case is inventories, which decreased cash by $18 million in the latest quarter. This means that the company's inventories are increasing but are not being turned over. On the flip side, Ducomunn seems to have been paying off its payables and other accrued liabilities, which is a positive sign for the company.

Another source of hemorrhaged cash comes from capital expenditures and the acquisition of LaBarge for $305 million. The acquisition is expected to be accretive to 2012 earnings. For right now, Ducomunn has lost a significant amount of cash due to the acquisition. To cope with the massive outflow, the aerospace firm issued about $390 million in debt securities in the second quarter. In the third quarter, it only repaid $1 million of the entire debt load. Ultimately, the company has been cash flow positive since the beginning of 2011, but investors have to keep in mind that Ducomunn has to pay off its debt in a timely manner.

Based on the cash situation, it is not hard to see that Ducomunn's current assets have decreased slightly from the previous quarter. Although a significant amount of goodwill and property, plant, and equipment have been accrued, assets have been progressively decreased. As mentioned earlier, short-term and long-term debt have increased significantly. For example, long-term debt increased from $22 million to $391 million. Furthermore, payables and accrued liabilities have increased despite the contraction in assets. As investors may notice, the debt loads were initiated in the second quarter, and have not been paid off in the third quarter. This could be a major warning sign.

Investors are also interested in other factors, apart from the fundamental, historical aspects. For example, Anthony Reardon, the CEO of Ducomunn, purchased 2,000 shares of the company at an average price of $12.20. Insider buying is always a good sign, unlike insider selling, which could mean that management itself is not confident in future performance.

From a technical perspective, a descending continuation triangle has formed on Ducomunn's chart. Depending on how you draw the triangle, the bearish sign points to a price target from $9 to $11. The pattern is derived from lower highs and lower lows. The stock action is predicted to occur after the price breaks through the triangle formation to the downside, confirming a negative downtrend.

Investors need to be aware of all the risks associated with Ducomunn, especially in a volatile market. However, as an operator in the aerospace and defense industry, its risk of dissolution or complete breakdown is much lower than a company operating in the financial services. During a time of economic and geopolitical turmoil, investing in this particular space may be of interest to certain investors. In order to make the best possible decision, investors should learn more about the company's management and its exact product offerings.

Ducomunn is currently trading at $12.40, down almost 43% for the year.