Spirit AeroSystems – Too Hated?

The aerospace supply chain is decimated. Everything has stopped. Airline fleets are parked, Boeing and Airbus have dramatically reduced production schedules, and uncertainty is high.

Spirit AeroSystems has been particularly hard hit. The company supplies 70% of the structure on the 737 Max, which represents ~50% of the company’s revenue. Critically, the company is absolutely integral to Boeing’s supply chain. Therefore, Boeing supports the company when needed. This is important because it indicates that Spirit isn’t Boeing’s whipping boy and there is a symbiotic relationship.

Here is Tom Gentile, Spirit’s CEO, discussing the company’s current problems at the Morgan Stanley Virtual 8th Annual Laguna Conference:

“Our biggest program is the 737 MAX. We’re proud partner on the MAX, but obviously
that’s been a difficult situation. We make 70% of the structure on MAX, and historically
represents 50% of our revenue. So when that got grounded last year, after the second tragic crash, it was very difficult situation for Spirit. Boeing suspended deliveries at that
time, but we kept producing at 52 aircraft per month, until in December, Boeing actually
stopped production. At that point, we faced at Spirit, a very significant challenge, because
it did represent half of our revenue. So, we negotiated a new record with Boeing at 216
aircraft for 2020. Which was about a 60% reduction.

Then when the pandemic hit, obviously that was another challenge, and we renegotiated down yet again to 125 aircraft. In June we agreed a third production change with Boeing at 72 aircraft for 2020. But the pandemic also impacted widebody production, particularly because of international travel, and so the 87 program is gone from 14 aircraft per month, It will be 6 next year and 777 is gone from 5 aircraft per month last year, to two next year. And of course, this is not just Boeing, Airbus is also impacted and they’ve reduced their
production by 40%. So, the combination all of the production I guess and cuts really
impacted Spirit.

In the first quarter, our revenue was down 50%, in the second quarter, it was down 68% and we’ve earned a lot of cash from both of those quarters, particularly since some of the working capital, the inventory was already on order and we couldn’t turn it off fast enough, so it accumulated. It will burn off in the future, but with production rate slow right now, it’s burning off less fast.”

So much for an aerospace “super cycle!” Surely the market remained rational and realized this is a “temporary” problem. Surely the market valued Spirit on a long term basis because rates are so low. Right? Wrong!

There is no doubt that Spirit Aerosystems common equity was impaired by the pandemic. Depending on the assumptions, it’s pretty easy to see how the equity was impaired by 40-60%. That said, $2.1Bn is 27.6% of $7.6Bn (perhaps implying this equity price overshot it’s impaired value).

Moreover, it’s possible the world changed forever and pandemics will occur regularly. If that’s the case the impairment may be justified. In fact, the equity may be worthless. However, if 2020 is a unique case it’s possible the period from 2009 to 2019 is a more appropriate time period to determine “normalized” cash flows. Over that time period, Spirit generated an average of $236.6mm of free cash flow.

The current equity is valued at $2.1Bn. If 2009-2019 is a reasonable proxy for normalized cash flows the free cash flow to equity yield now exceeds 11%. In 2017 the outlook was rosy. At that time the common equity traded for almost $10.0Bn. While that valuation may have been egregious, it shows how excited market participants once were about this entity. At $2.1Bn, market participants might be just a little too negative on this entity.

Therefore, this could be worth a research project for anyone looking for a reasonably priced common equity.

Disclosure: SCG recently established a small position in the common equity of this entity.

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