Please note: All figures are in CAD unless otherwise stated. All data as at market close on Friday, August 11, 2017. <\/p>\n
Magellan Aerospace (OTCPK:MALJF) [TSX:MAL] reported Q2 earnings after market close on Tuesday, August 8 - and by the looks of the chart, investors were disappointed. Magellan initially fell 2.3% after reporting earnings and extended those losses to fall 10.3% after two analyst downgrades. So, how bad were its numbers? <\/p>\n<\/p>\n
Source: YCharts <\/p>\n
While Magellan's gross profit margin remained consistent, its revenues and earnings declined y\/y due to lower production volumes and a one-time $1.3 million legal settlement. I believe that this decline is temporary; moving forward, I expect Magellan's revenue and profitability, particularly in the US and Canada, to increase due to higher production volumes from the 737's accelerated production schedule. <\/p>\n
Source: Company Filings <\/p>\n
Source: Company Filings <\/p>\n
Magellan designs\/manufactures complex aircraft components and provides MRO (maintenance, repair, and overhaul) services. They specialize in producing aircraft structural components, precision machining of metal alloys, composites, complex castings, and engine components. Within the aerospace industry, Magellan operates in two product groups: aerostructures and aeroengines. They operate 16 facilities throughout Canada, the United States, the United Kingdom, India, and Poland. <\/p>\n
The following process flow diagram illustrates the areas Magellan operates in: <\/p>\n
Source: Aviation Week <\/p>\n
In FY2016, Magellan derived 73% of its revenue from commercial markets and 27% from the defense market (more on this later). In my opinion, Magellan maintains an optimal balance between commercial and defense revenue. Magellans current revenue mix allows them to take advantage of the record backlog in commercial aircraft, while maintaining exposure to the more cyclical, but more lucrative government defense market. <\/p>\n
Source: Company Filings <\/p>\n
Boeing (NYSE:BA) and Airbus (OTCPK:EADSF) [EPA:AIR] have seen robust growth in commercial aircraft demand, primarily due to a rising middle class in emerging markets, greater demand for air travel, and high oil prices which accelerated fleet replacement schedules. This has led to a record commercial aircraft backlog, which Boeing and Airbus are tackling by increasing production. For example, Boeing is accelerating production of 737s from 42 per month in 2016 to 57 per month in 2019, increasing by 5 737s per month each year. In turn, Boeing and Airbus need their parts suppliers to meet their accelerated production schedules. <\/p>\n<\/p>\n
Source: Deloitte <\/p>\n
Magellan is well-positioned to take advantage of the OEM's accelerated production schedules through their \"key supplier\" status. OEMs typically enter into multi-year sole-source agreements with parts manufacturers for a specific component due to the complexity and cost of developing the part. As part of the contract, Magellan assumes some design, development, and engineering costs in manufacturing the new part. New aircraft programs require further project risk\/development cost sharing, in exchange for a lifetime agreement to supply the part. <\/p>\n
Magellan presently produce parts for all major aircraft projects and those in development, as illustrated below. Looking ahead, with Magellan's strong relationship with OEMs, I anticipate they will renew contracts coming due in 2017-2018 and secure new long-term contracts, thus providing a strong revenue base. <\/p>\n
Timeframe <\/p>\n
Aircraft Project <\/p>\n
Work <\/p>\n
Est. Annual Revenue <\/p>\n
2010-2020 <\/p>\n
A350XWB <\/p>\n
Machined Detail & Structure Components <\/p>\n
$10mm <\/p>\n
2011-2021 <\/p>\n
A350XWB <\/p>\n
Machining & Treatment of Lithium Components <\/p>\n
$2mm+ <\/p>\n
2012- (Cont.) <\/p>\n
B737, B747, B767, B777 <\/p>\n
Hard Metal Structural Assemblies <\/p>\n
2012-2017+ <\/p>\n
B787 <\/p>\n
Hard Metal Structural Assemblies <\/p>\n
2012-2017 <\/p>\n
A320, A330, A380 <\/p>\n
Aluminum & Lithium Structural Wing Components <\/p>\n
53mm <\/p>\n
2013-2033 <\/p>\n
F-35 (BAE Systems) <\/p>\n
Complex Composite Horizontal Tail Assemblies <\/p>\n
$60mm <\/p>\n
2013-2017 <\/p>\n
A350XWB <\/p>\n
Machined Structural Fuselage Components <\/p>\n
$11mm <\/p>\n
2014-2018 <\/p>\n
A320 (incl. Neo) <\/p>\n
5-Axis Machined Wing Ribs <\/p>\n
$5mm <\/p>\n
2014-2024 <\/p>\n
B737MAX <\/p>\n
Landing Gear Kits <\/p>\n
$50mm <\/p>\n
2015-2025 <\/p>\n
Pratt & Whitney <\/p>\n
Magnesium & Aluminum Castings <\/p>\n
$25mm <\/p>\n
2016-2018 <\/p>\n
F-35 (BAE Systems) <\/p>\n
Machined Titanium Components <\/p>\n
$35mm <\/p>\n
2016-2020 <\/p>\n
A320\/330\/350\/380 (GKN Aerospace) <\/p>\n
Aluminum\/Titanium Parts & Assemblies <\/p>\n
$42mm <\/p>\n
2017- <\/p>\n
B777X, B787 <\/p>\n
Machined Titanium Components <\/p>\n
Source: Company Filings <\/p>\n<\/p>\n
Magellan currently produces tails to be used on F-35 fighter jets for Lockheed Martin's (NYSE:LMT) subcontractor, BAE Systems (OTCPK:BAESF) [LON:BA]. Presently, the US is planning on ordering ~2400 aircraft, with full delivery not expected until 2040. There are concerns about lost orders from the programs numerous delays and cost overruns; smaller customers and partners, such as the UK and Canada, have threatened to cancel F-35 orders. I believe that the risk to Magellan is minimal, given that the United States (which makes up the bulk of the F-35's orders) is unlikely to do so. After all, the Pentagon described the program as \"too big to fail\" due to significant sunk costs in the US $1.5 trillion project. Even with cancellations from other partner countries, the F-35 project will provide Magellan with stable production for the next 20 years. As such, I believe further delays in the F-35 program will have a negligible impact on Magellan. <\/p>\n
Magellan introduced the Magellan Operating System (MOS) in 2007 to focus on operational efficiencies by standardizing and instilling best practices in their plants. In new acquisitions, Magellan strives to apply the MOS standard practices to mitigate acquisition risk. Since 2012, they have steadily increased their gross profit margin, EBITDA margin, and their FCF significantly, highlighting managements ability to execute the business. <\/p>\n<\/p>\n
Source: Bloomberg <\/p>\n
Source: Bloomberg <\/p>\n<\/p>\n
Source: Bloomberg <\/p>\n
To meet OEM demands for defect free products & 100% on time performance, Magellan is increasing investments in technology, capability, and capacity. This year, Magellan is also targeting employee communication and engagement. As a result of these investments, I believe that Magellan will be able modestly increase their gross profit margin, EBITDA margin, and FCF yield moving forward. <\/p>\n
Since the US election, Magellan has diverged from and underperformed their parts manufacturer and OEM peers. I believe that concerns about President Trump and NAFTA renegotiations are overblown. Since the US leads the global aerospace industry with US $134.6 billion in exports in 2016, I believe that President Trump would not disrupt the aerospace industry. In the recently released NAFTA renegotiation objectives document, the USTR specifically wants to maintain existing reciprocal duty-free market access for industrial goods. As such, I see little impact on Magellan's operations and profitability and believe that their underperformance since the US election is unjustified. <\/p>\n
Source: Capital IQ <\/p>\n
Based on my comparable company analysis of comparable airplane parts manufacturers based in North America, Magellan trades at a discount to its peers on both P\/E and EV\/EBITDA metrics. Additionally, Magellan carries less debt relative to EBITDA than its peers, with Net Debt\/EBITDA of 0.9x vs. the peer median of 1.7x. Source: Capital IQ <\/p>\n
I believe that Magellan should trade at a premium to its peers, given their superior ROIC, margins, and future growth prospects. I believe that Magellans EV\/EBITDA multiple will expand to at least peer median levels within a year to correct MALs present undervaluation. <\/p>\n
However, to be conservative, I used a 9x (slight discount to peer average of 9.47x) 2017 EV\/EBITDA multiple. I arrived at a target price of $26.32, implying 43% upside. A sensitivity analysis for the relative valuation highlights a range of target share prices based on EV\/EBITDA multiple expansion and forward EBITDA estimates.<\/p>\n
Source: Capital IQ <\/p>\n
As a current shareholder, I've been using pullbacks to snap up more shares. Moving forward, I believe that Magellan will be able to improve both its top and bottom line. Its recent revenue decline should reverse as OEMs accelerate production to meet record aircraft demand. Particularly, increased 737 production should benefit Magellan's North American facilities, which saw revenue decline in 1Q17. Magellan's operational adjustments should continue to produce higher margins and help its bottom line. Ultimately, I think Magellan's significant discount to its peer group is unjustified given its strong operations, high margins, and high return on capital. <\/p>\n
This article is part of Seeking Alpha PRO. PRO members receive exclusive access to Seeking Alpha's best ideas and professional tools to fully leverage the platform. <\/p>\n
Disclosure: I am\/we are long MALJF. <\/p>\n
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. <\/p>\n
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks. <\/p>\n
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Original post:<\/p>\n
Magellan Aerospace: Too Cheap To Ignore - Seeking Alpha<\/a><\/p>\n","protected":false},"excerpt":{"rendered":" Please note: All figures are in CAD unless otherwise stated. All data as at market close on Friday, August 11, 2017 Continue reading