It has been predicted that over the next several years a boom will take place in commercial aerospace orders (Figure 1). These orders are cyclical, but lag the economy to some extent as seen in the graph below. For example, after the September 11th terrorist attacks and due to the 2000 recession, orders were curtailed for some time before beginning a rebound in 2005. Likewise, the 2008 financial crisis has caused a lagging curtailment of demand that seems to be on the verge of bottoming. As a result, it is expected that strong demand in aerospace companies is to be expected for the next several years and companies within this sector are likely to be strong investments.
Figure 1: The Coming Aerospace Boom – Airbus and The Boeing Company (NYSE:BA) Order Backlog
Astronics Corporation (NASDAQ:ATRO) is a manufacturer of specialized lighting and electronics equipment for commercial and military aircraft. The company reported several weak quarters last year as the price bottomed near $20 per share in November. Specifically, the company reported narrowing profit margins and profit of $0.39 and $0.33 in Q2 and Q3 2012 versus analyst expectations of $0.47 and $0.43, respectively. Profits rebounded somewhat to $0.37 in the fourth quarter, but given the uneven performance and lack of a clear growth trajectory the 40% rise in price since last year seems to be at least fairly discounting the company’s performance.
Lockheed Martin Corporation (NYSE:LMT) is a behemoth of aerospace, but derives the vast majority of its revenue from government defense spending (80% of last year’s revenues). Lockheed is not a good play on commercial aviation spending, however, compared to its peers it may be underpriced due to concerns over curtailment of government defense spending. Given the present escalation of tensions in Korea and unlikelihood of substantial action to cut defense spending, Martin Corporation (NYSE:LMT) is most likely a very attractive investment opportunity. A false bearish thesis is always bullish and it is anticipated that concern over cuts to defense spending are overblown at this time.
Precision Castparts Corp. (NYSE:PCP) is a manufacturer of jet and industrial gas turbine engine components. The aerospace market accounts for 62% of sales, with power generation comprising 21% and the remaining 17% coming from automotive and general industrial sales. The company boasts fantastic profit margins at a pretax margin of nearly 26%. The specialized parts that the company produces afford a strong moat. At the present time the company appears fully valued at 20.5 times trailing earnings, but it represents a strong buy on any available weakness.
Table 1: Comparables for Several Aerospace Firms
Triumph Group Inc (NYSE:TGI) is a manufacturer of aircraft components and structural assemblies with 65% of revenue coming from commercial aviation or private jets and most of the remaining revenue coming from military spending (32%). In 2010 Triumph acquired Vought Aircraft Industries from the Carlyle group for cash and stock. The acquisition has been accretive to margins and earnings for a price of $1.66 billion. Given that 55% of Triumph’s revenue comes from an acquisition that cost 46% of its present market capitalization, the acquisition seems to have been a wise move. Add to that synergies between the companies, which have caused margins to expand considerably and in total the acquisition has been a tremendous boon for Triumph Group Inc (NYSE:TGI)shareholders. A fair amount of debt was issued for the acquisition, however, as a percentage of capitalization the debt stands at 34% or about 1.81 times last year’s EBITDA.
Given the strong growth Triumph Group Inc (NYSE:TGI) has achieved in the past several years, 11 times TTM earnings seems a low price to pay, corresponding to a PEG of 0.87. The chart below outlines these observations: notice how profit margins have moved higher due to the Vought acquisition in 2010 and that given the recent pullback the company now trades near the bottom of its EBITDA/EV valuation over the past fifteen years.
Figure 2: Triumph Performance and Valuation Since 1997
After the most recent earnings report, Triumph Group Inc (NYSE:TGI) has taken a tumble and this is viewed as a compelling buying opportunity. The earnings report itself was very strong and reported quarterly earnings of $1.68 per share, exceeding consensus analyst expectations of $1.59. However, the share price fell around 10% on weaker than expected guidance for the fiscal 2014 year of $5.65 to $5.75 per share versus expectations of approximately one dollar higher.
Management commented on the gap for 2014 earnings during the conference call: “Fiscal ’14 has a large hole in it associated with the 767’s move from commercial to tanker freighter. This includes an almost 50% reduction in deliveries that will happen in Q2 through Q4. That reduction will not only create a loss of revenue and profit but also will impact our cost and factories where 767 have a substantial part of the work. The good news is that with the freighter and tanker orders, we believe this could be largely an anomaly for ’14 only.”
Standard and Poor’s continues to expect 2015 earnings to come in around $7.50 and Triumph Group Inc (NYSE:TGI) management maintained its longer term guidance for 2015 and 2016 with $8.25 expected for the latter year. If the earnings impairment only pertains to 2014 it is only an issue of one dollar per share, a good deal less than the market is discounting.
Given the unchanged longer-term guidance, the drop in the stock price appears to be an opportunity to buy shares on the cheap. The 10% reduction in the share price is discounting the fiscal 2014 earnings as a permanent reduction rather than a one-time factor and Eric Hugel, an analyst who covers Triumph for S&P, raised his twelve month target price to $90 even considering expected 2014 performance.
Lastly, it should be noted that CEO Jeffry Frisby has made substantial purchases of his own company’s stock at a price a good deal higher than what is presently available on the market. The CEO bought 14,737 shares on Apr. 26 for $79.80 at a market value of $1.18 million at the time. The stock is now trading nearly 10% lower. Being able to buy the stock for 10% less than the CEO did is in my view a very compelling opportunity. Alternatively, I would recommend selling a September $70 Put, which should fetch approximately $3.75 given the current bid/ask prices. In that case, you can either own Triumph Group Inc (NYSE:TGI) for $66.25 or be paid a 5.66% premium on at-risk capital over the next 140 days, an annualized return of 14.78% if the shares are not assigned.
The market can be volatile in the short-term; however, Triumph’s long-term prospects are still very bright. If you own Triumph I would continue to hold and if you don’t, it is a steal at the current price.
Brendan O’Boyle has no position in any stocks mentioned. The Motley Fool recommends Precision Castparts. The Motley Fool owns shares of Lockheed Martin.
The article The Coming Boom in Aerospace: Which Companies Are Poised to Profit? originally appeared on Fool.com.
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