Description

Seeing as there have been a number of updates since the last VIC post on ALOT, I will attempt to add some detail in this write up. To begin, though, I think an investment in the company at today’s prices represents one of the most asymmetric investment opportunities I can find, and the best part is that it should work despite whatever economic environment we’re about to enter.

The thesis can effectively be boiled down to the fact that (a) a recovery in aircraft production rates will happen at some point – regardless of a recession - and (b) the business will lap some issues in its non-aerospace related segment. Assuming these happen over the next 3-4 years, I arrive at fair value of $25-30 per share compared to today’s price of ~$12 per share.

While Astronova on its own is a decent little business (which I’ll get into soon), you also have:

• A skilled management team who previously worked at Danaher and have shown good capital allocation skills;
• A board that includes previous Danaher employees (one currently runs a very successful Danaher like business that has also been written up on VIC);
• Insiders recently purchasing ~$1.5 million of stock (for a company that has a market cap <$100 million);
• A stamp of approval from well-regarded investors including Peter Kamin (owns 6% of the company), Royce (7% of the company), and Askeladden Capital (7% of the company);
• Low downside – the business trades at ~13-14x current annualized profitability, though this includes the fact that the most profitable segment (aerospace related) is essentially already operating at recessionary levels and is very unlikely to decline further

A reasonable probability of at least a double - combined with low downside - strikes me as a very good bet to make.

Now onto the more detailed discussion.

(1) Profitability in the aerospace business is likely to recover.

Astronova manufacturers printers that go into the cockpits of planes which are used by pilots to print things like manifests and other flight specific information. It is also unlikely that cockpit printers go away: having hard copies of flight information is important as it provides an extra level of redundancy, pilots often prefer to print various documents for ease of use, and on some routes printers / hard copy material is required. Despite also having iPads, pilots still use the printers “every day”.  

Astronova’s printers have exclusivity on Boeing and Airbus narrowbodies which make up the vast majority of the market. The segment is tied to airplane production rates which have been in a depression for 3-4 years due both to Covid and more recently supply chain issues preventing Boeing and Airbus to produce at their target rates (which incidentally are well above pre-pandemic). Eventually, though I don’t know when, it seems reasonable to assume that the industry will reach these targets or get to something close (the backlog of planes continues to grow given significant underproduction by the OEMs).

Most notably, though, is that production rates, while typically cyclical, should not be affected by whatever economic environment we’re about to enter. I wrote the below in response to a comment on the recent ATRO thread, but have reposted it here as it best captures my thoughts on the matter:

“I think that [the logic of airplane production rates being cyclical] is the common misconception right now with regard to the industry. While, yes, it is cyclical to be tied to new planes and retrofits (not speaking to Astronics specifically, I don't know the business), it isn't right now. We just went through a 3 year depression in aircraft build rates. Backlogs are quite high at the moment, and the order pace has not slowed. Book to bill seems well over 1 and OEMs are underproducing relative to demand (they have been for the past two years). Inventories in the aerospace supply chains are also running light since most players destocked during Covid and they're having trouble building them back up. Most industries have seen supply chains loosen up and generally get back to normal; aerospace is still experiencing a host of issues that's holding back production.

If we were to have a recession, at the very least it's not clear that it will do anything to current production rates by Airbus and Boeing. Right now is very different than say 2008 when the OEMs were generally chugging along in production rates and then a train hit them with the recession. For reference, on the narrowbody side, Airbus is producing at ~40-50 per month with a goal of 75 per month in a few years while Boeing is at ~35-38 per month with a goal of getting to 50 per month - so, in effect, the OEMs are producing at 65% of "goal"....it's not like they are producing where they want to be right now, which should be a buffer against a recession. 

As opposed to a drop in production rates, I think the real risk right now is whether the aerospace supply chain can handle an increase in production rates. Recent news tells us that maybe it can't: recently some engine news came to light out of Raytheon, and then also you have the quality control issues over at Boeing with Spirit. Both of these will hit production rates in the near term, though over a long enough time frame (say 3-5 years), maybe it’s appropriate to assume these resolve themselves.”

Currently, the segment is producing ~$9-10 million in EBITDA. At pre-covid rates (so not assuming that the OEMs hit their target rates) the segment would produce closer to $20 million. The latter figure is not easily discerned from historical filings because there are a number of one-time issues obscuring profitability as well as royalty payments that flow through COGS and are only mentioned in the Ks and Qs (these will eventually go away, and I treat them as net debt).

Moreover, there is the opportunity to earn well above the $20 million figure as the company currently plans to discontinue the products that it acquired from Honeywell (which gave it a foothold in the aerospace market, and which still generate royalties for Honeywell) in favor of replacing them with their own higher margin printers. This should also be fairly easy and low risk – the company already has the agreements with Boeing and Airbus, and so long as their printer is not demonstrably worse (after all, Astronova has been the one manufacturing and selling the Honeywell printers, so they should have good insight here), it should be easy to replace and would lead to higher margins than in the above case.

As with most niche aerospace parts businesses, the cockpit printer business is a good one: normalized segment EBITDA margins are ~35%. Note that EBITDA is essentially pre-tax cash flow – there is very little capex required. It is also likely to stay a good business as barriers to entry are high – it would cost a competitor years of R&D / working with the FAA and millions of dollars to enter the space for what is a small end market that wouldn’t justify the cost (Astronova has the majority, and their sales to the space are <$50 million). The printers are already designed in on the new Airbus/Boeing models and as such have years of runway even if they were designed out of new models (which won’t be introduced until the 2030s, and then produced in the late 2030s).

(2) Profitability in the business’s product identification (PID) segment has been impacted by supplier issues that should go away over the next few years.

The product identification segment supplies small businesses (largely in the CPG space) with printers used to print labels on various products. Think of a pizza box with your local pizzeria’s logo or the label on some smaller brand’s lemonade in your local grocery store. This is also a decent business – roughly 60% of revenues are recurring (Astronova supplies customers with the ink and material) and is generally speaking recession resistant (CPG related businesses tend to do ok during bad times – you still need your food!). Organic growth in this business has been decent over the past decade or so and its pretty sticky given the razor/razorblade model.

Over the past year or so, profitability in the segment has been lackluster as one of the company’s key suppliers of ink had faulty product. This caused Astronova to foot the bill on retrofitting the printers at its customers, as well as taking the printers offline which resulted in less supplies driven revenue. The company is almost done with the retrofitting, and they are planning on introducing their own ink alternative which should both save costs relative to this supplier as well as lead to more consistent profitability once the issue is over with. Normalized EBITDA is probably conservatively somewhere in the range of $7.5-9 million for the legacy business.  

(3) The company announced a restructuring in its PID business, which combined with synergies from a recent acquisition should significantly enhance profitability in the segment.

In 2022, the business acquired a small competitor called Astromachine for roughly $18 million. Astromachine is generating somewhere on the order of $4 million in EBITDA (note that there is very little in the way of capital expenditures in this business, so this is basically pre-tax cash flow). As such, management purchased the asset (primarily with debt) for <5x pretax cash flow – clearly a great use of capital. The current plan is to integrate parts of their legacy PID business with this one as Astromachine manufacturers their printers in house, whereas the legacy PID business used various third parties.

In combination with the acquisition, management recently announced a restructuring program whereby they will discontinue certain low margin product and further consolidate with Astromachine. They are spending $3.2 million to do so, though they think the program will generate >$2.4 million of savings. The program should be completed over the course of the year.

(4) Pro forma for each of these developments, the company sports a very low valuation.

Assuming a return to pre-covid airplane production rates (in my view a question of when, not if), the aerospace segment will likely produce somewhere in the range of $20 million in EBITDA. As I said previously, there is clearly the opportunity to earn well above that moving forward, but I’ll use the conservative case here.

Assuming the PID business returns to some level of pre-pandemic profitability, it will generate ~$8 million in EBITDA. Adding on the recent acquisition and also giving credence to restructuring savings, the segment as a whole should generate roughly $14.5 million in EBITDA.

SG&A expenses should run at roughly $12.5 million when revenues recover in the aerospace segment. So in total we have consolidated EBITDA of $22 million on a normalized basis,  and after tax operating income at that rate should be ~$13.5 million. Adding back excess depreciation / amortization over maintenance requirements gets you to ~$16 million in free cash flow.

At a modest 13x (the company would be generating 15-20% returns on tangible capital, so this seems more than appropriate and is probably conservative), the business is worth $210 million. Less net debt and you get a target share price of ~$25 per share today. Obviously this will not happen over night, so assuming it happens sometime in 2026 or 2027, the business should generate roughly $20-30 million in interim cash flow between now and then. Add that in and you get to a share price of ~$28 which compares very favorably to today’s share price of ~$12. The company is also currently holding excess working capital as a buffer for supply chain issues, though this should go away over time (this is not accounted for in the above).

So in all the investment is really pretty simple. A recovery in profitability in the aerospace business, combined with a lapping of issues and an integration of a highly accretive acquisition in the product identification business, should lead to a substantially higher share price. Management seems honest, generally skilled, and own a good chunk of stock. Other intelligent investors are also involved (though I would refrain from using this as a basis from which to make an investment). I really don’t see a whole lot of risk here, and is why I am particularly attracted to the idea.  

Risks:

Cockpit printers are designed out of newer plane models (regulation is notoriously slow to change in the aviation industry, and currently some routes require the use of hard copy material like manifests or schedule changes; conversations with a pilot friend also highlights that pilots generally use printers all the time despite still having an iPad in the cockpit)

Legacy PID margins never recover (the legacy business has seen margin erosion over the 2018-2023 period, though it remains to be seen if this is a structural issue; nonetheless, the valuation is low enough such that the answer to this question isn’t particularly impactful to business value)

OEMs never hit their production targets, and perenially operate below demand due to various issues (supply chain or quality related). This is clearly a risk, and one that has reared its ugly head here over the past couple of years. It may go on for a long time, though its hard to know. I do, however, feel that eventually OEMs will produce at the level of underlying demand..otherwise backlogs would be forever rising and would never get worked down. Perhaps to make up for it, OEMs would start charging ridiculous prices for slots, but at some point it would become cost prohibitive to do so (airlines cannot pass on ever rising plane costs ad infinitum). Similarly - at some point - existing fleets have to be refreshed given the intense regulatory scrutiny involved in aerospace, and you cant refresh the fleets if new planes are never produced at a rate that satisfies underlying demand.  Nonetheless, even if this were the operating environment moving forward, there is effectively no fundamental downside from the current price of ALOT. 

DISCLAIMER: The Author currently holds a long investment in the securities of Astronova (Ticker: ALOT) and stands to benefit should the price of the security rise. The Author may buy or sell long or short securities of this issuer and makes no representation or undertaking that Author will inform the reader or anyone else prior to or after making such transactions. While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note and disclaims any obligation to update such information. The views expressed in this note are the sole opinion of the Author, which may change at any time. The reader agrees not to invest based on this note and to perform his or her own due diligence and research before taking a position in securities of this issuer. Reader agrees to hold Author harmless and hereby waives any causes of action against Author related to the above note. This written note should not be construed as a recommendation to buy or sell any security or as investment advice.

Catalyst

Recovery in airplane production rates

Realization of cost benefits from recent restructuring in PID and further Astromachine integration

Release of excess working capital