Description

Apr 4, 2022 - Astronics (ATRO) is a small, extremely depressed aero defense supplier.   As of 2018, the last normal year, revenues were 80% commercial aero, 10% defense, 6% biz jets and 4% other.  There is also a small electronic test business that I’ll ignore for now.   Over half the profitability comes from ATRO’s near monopoly position in in-seat power distribution – running power to the seat so that airline customers can charge their phones and laptops (this also powers seat back displays).

At the current share price of $11.50, ATRO has a market cap of $350m.  There’s $130m of debt out, $22m of pension, some other liabilities and receivables – lets say EV of $500m.  ATRO is currently running breakeven but in 2018, ATRO did over $100m of adj. EBIT in aerospace + corporate plus another $10m in the test business.  (2018 had ~$30m of one time costs that were clearly broken out by management at the time and $20m of amortization of intangibles.  The normal operating margin for this biz is mid teens – in line with other high quality aero suppliers / industrials.) 

I think ATRO will ramp back to these numbers by mid decade with the commercial aero recovery.  So sub 5x normal EBIT which is probably 3 – 5 years off.   

Beyond the medium term recovery, in seat power is only about 50% penetrated and should be a growth market going forward – eventually every seat will have power.

And ATRO should be cash generative in the interim as things start to recover.  As of 21Q4, ATRO has a record backlog and book to bill is running at 1.5.  For 2022, management is guiding to $450 - $500m in revenue, a $100m - $150m YoY improvement, and Astronics should be comfortably profitable. 

I don’t talk to a lot of other investors, but I think there are three issues / hangups.

1)  Revenues have trailed other aero defense suppliers.  Most of ATRO’s commercial aero exposure is tied to new deliveries (line fit) with an over exposure to Boeing.  This follows deliveries, which have been on the floor due to COVID and ongoing production / certification issues with the 737 MAX and 787 plus additional downside from inventory swings.  But, about half of the ultra profitable in seat power biz is discretionary retrofit – airlines adding power outlets to older planes.  This is not the same as traditional aftermarket where airlines have to replace parts on a FAA mandated schedule.  This is discretionary capex by airlines which has been near zero over the last two years.   And so ATRO commercial aero revenues are depressed compared to other aero suppliers with more defense, FAA mandated aftermarket or Airbus exposure.

The precipitous drop in commercial aero revenues looks more reasonable when you adjust out the discretionary retrofit.   I make assumptions and compare Astronics line fit to Boeing, Safran Interiors (Zodiac), Collins commercial OEM (part of RTX and best in class) or LISI (95% OEM, primarily fasteners).   The discretionary airline capex YoY numbers are my extremely rough estimates.

2)  There have been a couple of new competitors entering in seat power, potentially busting up ATRO’s monopoly (KID Systems, owned by Airbus, has about 5% of the market, but customers really don’t like them).  If you Google around, you can find the new guys.  I’ve spoken to a couple handfuls of people in the channel and think that ATRO’s position is largely intact and new entrants are only grabbing share at the margins. 

It’s important to understand that ATRO and KID have the only line fit in seat power products.  Line fit means that they are FAA and OEM certified to be added to new Boeing and Airbus planes and the kit is actually installed on the BA/AIR line.  Becoming line fit is an expensive and onerous process – you have to go through both the FAA and the OEM’s onerous testing and investment requirements.  And so Astronics is relatively over engineered and expensive.  None of the new guys are line fit – BAE was trying but decided to exit.  Instead, the new entrants are approved as Supplemental Type Certificate (STC) 8110 minor modifications which allows them to get added as a retrofit.  Much less rigorous and onerous with lower specs and engineering.

Most airlines would much rather use Astronics’ line fit solution, even if it is more expensive.  The line fit solution rolls off the Boeing or Airbus line, ready to go.  And so the airline doesn’t have to pay for the engineering or install or hold the new plane out of service which is a big cost.  Significantly, line fit is paid for out of the capex budget (and financed in the debt or lessor market) while an aftermarket mod is paid for out of opex and hits margins – both the engineering and the downtime.  A couple of people told me that this is a big deal.  And most airlines want commonality among their planes and suppliers to reduce cost and complexity.

Secondly, the additional rigor of line fit certification is worth a lot to the airlines.   Lessors won’t deal with aftermarket mods and require that planes get returned to them with all original equipment.  Thirdly, most airlines would rather deal with the incumbent who has a reputation for engineering and service – Astronics will modify a solution to the customer’s specs and its worth a lot to know that they will be able to get replacement units in the future (power outlets, which customers touch on every flight, tend to break a lot).   And finally, there is an aesthetic advantage to being able to design the outlets into the seats, trays or arm rests rather than affixing an ugly box to the bottom of the seat.

And so most of the business that is going away from Astronics is with small and cheap airlines that use older planes.  Here is an excerpt from a call I had with a competitor who is doing a 50 plane mod for an EM airline.

“They are like the easy button – everyone knows them.   The large guys would never go with me.   A lot of the guys whose jobs are dependent on the decision will always pick Astronics….  Going line fit is a totally different beast.  Like buying a pickup and trying to compete in baja racing.   Its a lot – its incredible the amount of investment to get approved at Boeing….  [XXX Airline] took a risk on us.   [XXX] asked us why Astronics is so much cheaper coming from line fit but more expensive retrofit...  [XXX] new planes come with line fit [which I] assume is Astronics.”

3)  Poor view of management.  There have been a handful of mis steps and ATRO has been routinely missing guidance for four or five years now.  Full penalty box.  In 2017 – 2019 they called out $30m a year in extraneous costs from three lousy acquisitions (CCC, Aerosat and Armstrong).  They have been running close to their debt covenants even though there are a couple of levers they could pull to take down the debt.  I don’t understand what they are doing with their test business which has consistently under delivered.  And there are annoying super voting B shares – this was a novel scheme to reward long term shareholders but then they stopped issuing new B shares.

It’s been messy but I think this is typical small cap stuff.  And there is a longer history of great capital allocation - killer deals (the original AES in seat power deal in 2005, Peco in 2013 and ATS in 2014) and large, accretive buy backs (2016 – 2017 and 2019).  Management is forward looking about seeding and investing in new product engineering (power distribution and antennas).  The board owns 10% and CEO Pete Gundermann has his net worth tied up in the stock.  Pete is generally a straight shooter, gives reasonable answers to business questions and runs the company for the long term.

There is some additional complication, but this is the basic setup.  If anyone has additional info or a different view, I would like to hear it.   

This report is for informational purposes only and does not constitute investment advice.  The author may buy or sell securities mentioned at any time.   Please do your own work.

Catalyst

commercial aero recovery