Lakewood Capital 2017 Q3 Investor Letter

Finally, the company’s true earnings power is being masked by its foreign exchange hedging program. While Airbus sells planes in dollars, a portion of its cost base is in euros. Airbus manages this mismatch by aggressively hedging its currency risk for several years forward. For example, Airbus has hedged its 2017 production at 1.29 dollars per euro versus the current spot rate of 1.18 dollars per euro, but using current exchange rates, earnings would increase by roughly €1 per share.

As Airbus meaningfully grows revenues and profits in the coming years, we are hopeful that shareholders will view the company more similarly to its close peer Boeing (whose shares have gained around 100% in the past year). Despite having a relatively equal market share, Boeing has twice the enterprise value of Airbus. Based on the drivers detailed above, we expect Airbus to generate roughly €8 per share of earnings in 2020 with visibility to higher earnings power in subsequent years as the A350 goes from breakeven to normalized profitability. At a multiple of only 15x forward earnings (a sizeable discount to Boeing and a conservative valuation considering the company’s net cash position), we believe Airbus will be worth €120 per share, or 50% above the current price, in approximately two years.

Basically, Bozza is counting on a 20+% increase in production over the next couple of years, increased profitability of A350, and no losses from currency hedging. Are these developments likely to happen and will they lead to a 150+% increase in Airbus’ earnings in the next 2 years? It seems too ambitious as engineering problems aren’t always easy to solve and currency markets are unpredictable. Nevertheless, Airbus seems undervalued with respect to Boeing so it is definitely worth a look.