Description

AstroNova (ALOT) $13.75

12/27/19

Summary

AstroNova (ALOT) designs, manufactures and markets specialty printing systems, test and measurement systems and related services for select markets on a global basis. The two primary operating businesses deliver packaging label systems and aerospace cockpit printers.

AstroNova is a 50-year-old business that has been led by Greg Woods, a Danaher veteran, since 2014. It encountered the perfect storm in 2019 as the grounding of the Boeing 737 MAX in March 2019 adversely impacted its sales during a period of increasing investment in the business. As the grounding of the 737 MAX extended from the initial forecast of a few months to potentially 12-15 months, ALOT’s sales growth stalled and margins went into a tailspin. The stock has declined -25% in 2019 as a result.

There is reason to be optimistic that the underlying factors of ALOT’s very bad year should reverse in 2020. Given the small size of the Company, the high operating leverage and the paucity of analyst coverage, the stock could rise phoenix-like in the new year.

Background

AstroNova acquired Honeywell’s aerospace printer business in late 2017. This business provides printers for the Airbus A320 and the Boeing 737. In addition to $14.6MM in cash paid initially, ALOT will pay a royalty to Honeywell over the next 10 years with a $15MM minimum and is subject to paying Honeywell under a transition services agreement until all the business can be transferred to the Company.

When the 737 MAX was grounded in March 2019, ALOT had transferred the manufacturing over but still had some remaining transition costs to incur. Paying the minimum royalty at a time when few new sales were occurring was burdensome. In addition, the Airlines responded the grounding by postponing all non-essential maintenance in order to keep planes flying until they could return their 737 MAX planes to the active fleet as well as receive any new planes ordered. Consequently, ALOT’s aerospace printer sales were adversely affected as the customers were not willing to take planes out of service to make non-essential upgrades.

AstroNova has been investing heavily in their business over the last few years. Historically, this was a family run business until Greg Woods was hired in 2012 and made CEO in 2015. Woods has instituted the AstroNova Operating System which looks like the lean manufacturing systems developed at Danaher, his prior employer. They have established 8 new sales and service centers around the globe and are in the process of a major ERP system installation. The ERP system alone cost $1.5MM+ to date and should be operational soon.

The goal of the current five-year plan is to lift margins from 5% to 12% and grow revenues 15% per year. AstroNova was on the path towards achieving these goals when they hit the perfect storm of revenues stalling out because of the effects of the 737 MAX grounding, and the margin compression from negative operating leverage on increased investment without commensurate and expected revenue growth.

AstroNova operates in attractive niche markets. Its product identification segment sells label printing solutions which provide a range of capabilities at attractive price points that are highly differentiated. The aerospace printing business operates in a protected market of needing both FAA certification as well as airframe manufacturer approval for installation. While these are competitive markets, there is not the ability for a new entrant to just appear and disrupt the market. Printers are a classic razor/blade market with consumables and service representing significant recurring revenue on a growing installed base.

What is Changing?

While Boeing has yet to return the 737 Max to service, it has taken steps in the last few weeks that indicate that change is imminent. Boeing unceremoniously fired its CEO which paves the way for improved relations with the FAA and other governing bodies as well as with the airline customers.

AstroNova should be able to moderate its investment expenses until revenue growth reaccelerates. The ERP project is almost complete and the startup expenses for the sales and service centers is complete. The primary driver of ALOT’s performance over the next two years will be a) when does the 737 MAX return to service and b) when will the airlines be able to have enough slack in their fleet to accommodate routine non-essential maintenance (including upgrades/replacement of cockpit printers).

My working assumptions are that I would expect that the path towards recertification is bumpy given the parties involved, the public nature and the need to train pilots, but it appears that this should happen in the first half of 2020. This would make the first half 2020 story about ALOT moderating investment expenses, successfully completing projects like the ERP upgrade without incident and investors becoming more comfortable with the timing for the 737 MAX return to service. The second half of 2020 and into 2021 would involve increasing sales as Boeing ramps up 737 MAX production and the airlines are able to resume non-essential maintenance work on the remainder of their fleets.

My intuition is that AstroNova has been making the investments in global sales and service offices and a modern unified ERP system not simply to support the current business. I believe these foundational investments are being made to support an accelerated growth story in the mold of Danaher where they will resume making acquisitions of product lines that are adjacent to their current offerings that can leverage off their operational expertise and distribution platform to drive additional growth. If I’m correct, then this story has been delayed 18 months by the 737 MAX grounding and will still be realized.

Valuation

At $13.75, ALOT has a market cap of $97MM down over 50% from its midyear high before announcing the adverse impact of the protracted Boeing 737 MAX grounding. The balance sheet is clean with $13MM in net debt yielding an enterprise value of $110MM. It’s currently trading at 8.5x EBITDA and 10x EBITDA – maintenance capex for Fiscal 2020 (ending in January 2020). EBIT isn’t particularly insightful as there is substantial amortization expense from the Honeywell acquisition.

F2021 estimates are muted by the expectation that the first half is slow while the 737 Max is grounded and sales growth resumes in the back half of the year. F2022 should show a resumption of full year growth with strong comps in the first half. Most importantly, expectations will shift as soon as there is a firm date on the 737 Max return to service.

The stock is trading very cheap on F2021E and F2022E estimates. There is only one analyst covering the stock for a non-bulge bracket firm and at sub $100MM in market cap, ALOT is easily overlooked. I expect that a significant repricing could occur in early-mid 2020 as the clouds over the company dissipate. If it can resume its growth trajectory, a 12x multiple on EBITDA-capex is not unreasonable and would yield a price of roughly $21-22 in 2020 and $28-29 in 2021 for upside of over 50% and 100%, respectively.

I would expect upside to these figures are likely if the company can resume making additional tuck-in acquisitions using the Danaher playbook. The CEO is in his early 60s and owns 1.4% of the stock. There is plenty of room to grow this company and it may ultimately become an attractive acquisition target to another firm.

Catalyst

 Return of Boeing 737 MAX to service, resumption of revenue and margin growth, continued tuck in acquisitons.