Hawkeye Pride Rockwell Collins Inc. (NYSE: COL)

change in inflation for one year from September 2014 to 2015.12If inflation is higher than estimated, the Federal Reserve willhave to take that into account in their new interest rate.According to Janet Yellen, the Federal Reserve would like tosee inflation moving toward the annual two percent targetbefore raising rates.13commodities since 2000.23 In order to combat the lower demandfor aluminum, China has imposed a 15 percent duty rate onexports of aluminum ingots, which they believe will helpprevent economic turmoil in these emerging markets, and forcemore Chinese producers to keep their business within China,reducing supply to the rest of the markets from China.16If the Federal Reserve decides to increase interest rates inDecember, it will cause increased volatility in the equitymarkets, however after 2-3 months we believe the markets willreturn to current levels on an uphill slope. With the last threerate hike cycles, equity prices have fallen when the FederalReserve increased rates, yet in following months equity pricesmove higher as the better economic data is processed by themarkets.15Additionally, the slowdown is effecting the emerging marketsin Korea, Taiwan and Singapore, who are heavily technologyfocused and thrive off of Chinese manufacturing. Analysts atJP Morgan believe that the build-up is slowing down, whichpresents a positive outlook for the Chinese economy inupcoming years.17The Fixed Assets market will be more heavily influenced by thechange, and have already began to reflect a higher yield demandfor both short-term and long-term bonds. Historically, theFederal Reserve’s increase leads to higher short-term bondyield, due to investors selling them in anticipation of the FederalReserve rate hike.UnemploymentOn a macroeconomic scale, U.S. unemployment numbersappear favorable in the short term. Unemployment has steadilydecreased over the last nine quarters, and currently sits at 5.0percent.14 This 5.0 percent compares favorably with theaverage over the past 15 years of 6.1 percent, which capturesrecessions beginning in 2001 and 2008.15 Over the last year,unemployment has remained relatively unchanged, with adecrease of only 0.7 percent from October 2014.For the time being, we do not predict any change in theunemployment rate in the United States, however there is theopportunity for unemployment to rise in the future.Traditionally, unemployment is a lagging indicator of theeconomy, so we can expect to see an increase in unemploymentif we see the economy improving. The cyclicality of this issueis that if unemployment rises, more people will theoreticallyapply for unemployment benefits, raising tax rates tocompensate for these individuals, and an increase in taxes leadsto less disposable income, both of which draw money out of theeconomy.However, as aforementioned, we do not believe there will be animmediate change in unemployment, and the above concernsaddress a further outlook on the economy.International Markets Economic AnalysisChinaThe current economic slowdown occurring in China hasimpacted the global economy.The transition from amanufacturing and industrial centered economy to a consumerfocused one has led to a decrease in imports of commodities andindustrial materials. The decrease in commodities imports byChina is effecting the various emerging markets around theworld, including Brazil and Russia, who specialize in miningexports. The recent slowdown in China’s GDP growth hascaught up with this industry, after several years of capacitygrowth in order to fill China’s historically growing demand forWith regards to the United States Equity market, China’schange will not likely effect the US economy as much as somewould think, since the United States only accounts for about 1percent of China’s imports. Likewise, the European marketsonly account for 1.5 percent of Chinese imports, so there willnot be much of an effect on those markets by the slowdown aswell.The Central Bank of China has yet to utilize monetary policy tosoften the impact of their slowdown. They have yet to lowerinterest rates and bank reserve requirements, which wouldstimulate lending in China; however it does not seem likely thatthey will be using it given their recently announced 5-year planto stabilize growth.EurozoneThe Eurozone is finally seeing recovery from complicationswith Greece earlier this year. Demand for housing andcommercial building loans have increased in recent months,signaling an increased consumer confidence.The Bank of England has taken a dovish approach to changinginterest rates, which signals their belief that they have notcompletely recovered from economic turmoil. However, thiswill benefit the United States because the Federal Reservetypically will not increase interest rates if other countries areadjusting theirs as well.18Capital Markets OutlookBased on the previously discussed economic factors, we believethat the aerospace & defense sector will continue to performstrongly in the short-term and long run, based on strong demandfor commercial aircraft from emerging markets such as theMiddle East and Asia-Pacific region. On the contrary, one thingthat worries us in regards to the aerospace sector is thetightening of government spending. However, with the increasein violence produced by the Islamic State, we could soon see achange in the planned reduction of government spending. It isespecially clear that U.S. companies will continue to dominatethe A&D sector as nearly 60% of the sector is composed ofAmerican companies.47 The global commercial aerospacesector is expected to sustain its significant revenue and earningsgrowth, underlined by extended record-setting productionlevels both at the platform and in the supplier base.Important disclosures appear on the last page of this report.COL 4

Additionally, the markets are expected to see significantvolatility following an increase in the Federal Funds Rate,which will exaggerate the short-term volatility of returns in thissector.Industry AnalysisIndustry DescriptionThe New York Times defines the Aerospace and DefenseSector as consisting of companies engaged in the production ofspacecraft’s and commercial, military and private aircrafts. Theindustry also includes manufacturers of military equipment,such as tanks and related vehicles, bombs, missiles, associatednavigational and guidance systems, artillery, ammunition andother related weaponry.19This industry is heavily contracts based, and it requiressignificant capital to develop and manufacture advancedavionics equipment which provides a barrier to entry for newcompetition. While over 50 percent of commercial aviationproducts are exported, licenses to supply products togovernments are rarely issued to foreign firms and domesticfirms need to demonstrate a high level of corporate governanceto win contract agreements. Governments tend to favorcontractors that have a long history of work, rarely awardingcontracts to new comers.35 Major players in the industryinclude: Honeywell, Lockheed Martin, Northrop GrummanCorp, Raytheon, Rockwell Collins and others. Revenues incommercial aerospace tend to be driven by global economics,as more robust economies lead to increased travel demand.Defense, on the other hand, is driven by defense spendingbudgets and international military activity.Major PlayersWe will be focusing on Lockheed Martin ( 64.22B MKT CP),Honeywell ( 77.90B MKT CP), Raytheon ( 36.66 MKT CP),Northrop Grumman Corp ( 31.58B MKT CP), and RockwellCollins ( 11.15B MKT CP) as some of the biggest players inthis industry. These companies compete on price as well asinnovation and service on existing products.Research & DevelopmentResearch and development is one of the key drivers of value inthis industry as avionics products tend to be on the cutting edgeof innovation, particularly in the government sector. When wecompared our main contributors across research anddevelopment we found an industry average of less than 5percent of revenues. Rockwell Collins stands out as a clearleader in investment in R&D at 16 percent of revenues.R&D as % of Revenue20%15%10%5%0%Honeywell Rockwell Lockheed Raytheon NorthropCollinsMartinSource: BloombergEBITDAWe also evaluated our peer companies EBITDA marginsexpecting similar margins due to pricing transparency andcontract-based revenues. Industry average margins are around15-18 percent, with Rockwell Collins standing out at 23.1percent.Industry TrendsGovernment Budget SequestrationGovernment services will likely see a decrease in revenuesreflecting US government budget battles and the effects ofsequestration. A recently forged congressional budgetagreement offsets 22 billion of the 52 billion of mandated FY14 defense sequestration cuts, as well as 9 billion of FY 15cuts, resulting in base defense budget spending levels aroundflat with FY 13 for the next several years. The FY 15 Dept. ofDefense budget submission incorporating sequestration cutsshould improve overall contractor visibility and could spark areturn of M&A activity, although it also means specificprogram cuts will need to be digested.32MomentumIn 2012, the U.S. aerospace industry contributed 118.5 billionin export sales towards the U.S. economy. The positive tradebalance of 70.5 billion is the largest trade surplus of anymanufacturing industry and came from exporting 64.3 percentof all aerospace production.34 Aerospace exports employ morejobs than the export of any other commodity. On top of this, theUS is the largest aerospace market in the world. It is estimatedthat there will be a 3.5 percent increase per year in the numberof large commercial planes per year over the next 20 years,which comes to a total value of 4.5 trillion.EBITDA Margin2520151050Honeywell RockwellCollinsLockheed Raytheon NorthropMartinSource: BloombergCapital ExpendituresCapEx as a percent of revenue also provided us insight intoreinvestment requirements across the industry. Capex onaverage represents 2.3 percent of revenues in the avionicsindustry.Important disclosures appear on the last page of this report.COL 5

CapEx as % of RevenueCompany Analysis4%3%2%1%0%Honeywell Rockwell Lockheed Raytheon NorthropCollinsMartinSource: BloombergCompetitive RivalryCompetition in this industry is moderate, and dropssignificantly as you move into more sophisticated products.There are a handful of key competitors that hold mostgovernment contracts, and Boeing and Airbus tend to awardcontracts to a relatively small sub-unit of companies as well.Honeywell represents approximately 2 percent of both Boeingand Airbus costs, and most of the avionics expense for bothcompanies.Threat of SubstitutionThere is a low to moderate threat of substitution in theAerospace and Defense industry as it represents an integral partof military actions globally, and a significant portion of civiliantravel. Potential substitutes are slim on the government servicesside, while in commercial systems we see the automotiveindustry as a main threat.Threat of New EntryThreat of new entry in the aerospace and defense sector is lowbecause of high levels of required capital, patents, and theextensive use of service contracts in this industry. There is asignificant amount of R&D as well as manufacturing expensesrequired to develop and build avionics products. Also, mostavionics products are supplied on a contracts basis, andcontracts tend to be awarded to large companies with a historyof successfully filling orders. There is a high level of contractrollover in this industry.Industry DemandThe global commercial aerospace sector is expected to sustainits significant revenue and earnings growth in 2015, underlinedby extended record-setting production levels both at theplatform and in the supplier base.3 This growth is likely to bedriven primarily by increased production rates due to theaccelerated replacement cycle of obsolete aircraft with nextgeneration fuel efficient aircraft, as well as the continuedincreases in passenger travel demand, especially in the MiddleEast and the Asia-Pacific region. 32 Passenger and freight airtravel is increasing dramatically abroad. Passenger travel isexpected to increase 5.0 percent for the next 20 years, resultingin a need for increase in aircraft production.32Company OverviewRockwell Collins, a 5 billion revenue global company, focuseson aircraft electronics (avionics). Its business is conductedthrough three different segments- commercial systems (CS),government systems (GS), and information managementservices (IMS). In 2014, Rockwell produced total sales of 4.97billion, 4.52 earnings per share, and capital expenditures of 163 million.36 Although the company has performed stronglyin the past year, COL has not outperformed the S&P 500 sincethe middle of 2010.Source: AmigoBullsBusiness SegmentsCommercial Systems is primarily responsible for producingflight deck electronic systems. CS also performs a wide rangeof repair and overhaul services. Commercial system accountsfor 46 percent of all Rockwell Collins revenues37. Productswithin the CS segment include integrated avionics systems,integrated cabin electronics systems to create a more enjoyableflight, landing sensors, situational awareness and surveillancesystems such as enhanced vision, training simulators andweather radar. Maintenance repair for Rockwell customers isalso a large part of the CS department.Government systems, which accounts for 44 percent ofrevenues, is responsible for producing communication systems,navigation systems, avionics, and cockpit displays for militaryjets and rotorcraft. GS also produces navigation equipment thatis embedded in guided missiles. This department combinesflight operations with navigation and guidance functions,cockpit display systems, and helmet-mounted displaysproviding the pilot a 360-degree view of their perimeter to limitresponse time.Information management services, their third and finalsegment, accounts for 10 percent of all revenues. IMS is aprovider of communication, engineering, and systemsintegration support.37Important disclosures appear on the last page of this report.COL 6

Revenue by Department 2014 (inmillions)CommercialSystems 471 , 10% 2,209 ,44%GovernmentSystems 2,299 ,46%InformationManagementServicesSource: BloombergEstablishing a Global PresenceRockwell Collins is established globally. Some of their biggestcustomers include the U.S. Department of Defense, U.S. CoastGuard, civil agencies, airports, defense contractors, foreignministries of defense, manufacturers of commercial airtransport, business and regional aircraft, commercial airlines,the FAA, critical infrastructure operators, and major passengerand freight railroads.38 Rockwell utilizes a worldwide dealernetwork to distribute products and international salesrepresentatives to assist with international sales and marketing.It is important to note that international sales increased 20percent in the most recent year, growing to 38 percent of COL’stotal revenue. Expanding globally is a one of Rockwell’s mostimportant goals.39AcquisitionOn December 23, 2013, Rockwell Collins acquired ARINC for 1.39 billion, which was the largest acquisition in companyhistory. The acquisition was funded through a combination ofnew long-term debt and short-term commercial paperborrowings. This deal positioned Rockwell to become a leaderin the fast growing aviation information segment. In the threequarters that ARINC has been part of Rockwell Collins, theIMS business contributed 421 million in additional revenue totheir top line. This represents a 946 percent increase from theprevious year. Commercial systems represents over 85 percentof ARINC revenues32. With their recent acquisition, Rockwellhas made a clear effort to put more time and resources into IMSand CS rather than GS. We believe that governmental systemsrevenue will decrease 2 percent in the near term. However, IMSwill increase 14 percent as a direct result of Rockwell Collins’most recent acquisition.Catalysts for Growth/ChangeAs you can see in the chart below, fiscal year 2014 saw arevenue increase of 11 percent, bringing total revenue to 4.97billion. COL saw a 6 percent increase in commercial systemssales, bringing the total for that department to 2.3 billion.Sales201420132012U.S.Non-U.S.Total 2,993 1,986 4,979 2,827 1,647 4,474 2,9941,5374,531Source: COL 10-KThis change was driven by an increase in deliveries of airtransport aircraft and higher customer-funded development inbusiness and regional aviation. Government Systems salesexperienced a 2 percent decline to 2.2 billion. GS is a majorconcern for Rockwell - especially with the 2016 presidentialelection approaching. Although the Department of Defense’sbudget remains steady, Rockwell’s revenue obtained fromgovernmental services continues to decrease year over year.We expect to growth of 0.5 percent in Rockwell Collins’commercial systems unit. Trade association IATA estimatesglobal passenger air traffic grew 5.9 percent in 2014 aftergrowing 5.2 percent for 2013, and sees growth of 7.0 percent in2015.40 This change comes from an increasing recovery inworld markets and economies.We expect to see an increase in demand for commercial jetsfueled by growth in three areas. The first factor is demand fromemerging markets, such as Asia, the Middle East, EasternEurope, and Latin America. Many airlines in these regions haveremained profitable, and fleet sizes must rise to accommodateincreased demand. It is estimated that global airlines will need38,050 airplanes over the next 20 years, which comes in at avaluation of more than 5.6 trillion46. The second growth areais the need among airlines to replace aging and less fuelefficient planes to address rising fuel prices. Although the priceof oil is about 27 percent below its mid-2008 peak (and jet fuelis about 42 percent below its peak), prices remain persistentlyhigh, and many believe the supply-demand balance forpetroleum favors a return to higher oil prices in the future. Thetwo regions with the oldest (and largest) air fleets are the USand Western Europe40. Lastly, as technology continues toadvance, airplanes will need to be updated with the latestsystems.Combined Boeing and Airbus orders set new records in 2014and backlogs continue to grow, now containing around eightyears of production. Both companies have announcedcontinued production increases over the next several years andnew model introduction40. The highest level of orders since1970 was recorded in 2013, totaling 3,032 units. In 2014, ordersdropped slightly by 0.9 percent to reach 3,006 units40.While large sums of money from both base and supplementarydefense budgets are still benefiting contractors, it is importantto note th

Andrew-Namanny@uiowa.edu Connor Frischmeyer Connor-Frischmeyer@uiowa.edu Brandon Svac Brandon-Svac@uiowa.edu Coner Elliott Coner-Elliott@uiowa.edu Company Overview Rockwell Collins Inc. (NYSE: COL) is an industry leading aircraft electronics company. Rockwell focuses on three primary business segments: government systems, commercial