Description

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Investment Thesis & General Overview

·         Astronics is a small cap aerospace business with record backlog that is currently trading at one-third of its highest historical EV of $2.1B (which occurred in 2015 at the tail-end of the last aerospace upcycle) and less than half its average 2018 EV of $1.3B, prior to the 737-MAX issues and the pandemic

·         Astronics’ primary business is the design and manufacture of aerospace components, but the Company also operates a smaller, struggling electronics test systems business which will be largely ignored in this writeup

·         The Aerospace segment operates in 3 core sub-segments: Inflight Entertainment & Connectivity (IFEC), Flight Critical Electrical Power, and Aircraft Lighting & Safety. This business has historically been focused on commercial/business aerospace (80%+), but the Company has increasingly begun to branch more into military applications

·         We believe that the Company is currently trading at around 6.5x a VERY conservative, “normalized” mid-cycle earnings of ~$125m of EBITDA, and that there is room for significant upside in this number. We believe that once the supply chain completely normalizes and Boeing and Airbus production rates ramp up, the Company could generate around $1b in revenue and $170m-$190m of EBITDA

·         We believe an appropriate EV/EBITDA multiple for an average quality aerospace components manufacturer like Astronics should be between 11x-13x, in line with where the Company has traded recently.

·         We believe revenue and earnings will ramp quickly as Boeing and Airbus build rates improve, the aerospace supply chain eases up, and pricing on the Company’s long term-contracts reset over the next few quarters. EBITDA margins should reach high-teens late 2024.

Product Overview

Inflight Entertainment and Connectivity (IFEC)

·         IFEC makes up about 45% of Astronics revenues and includes:

o   In-seat power systems - electrical and USB outlets found in the seat as well as the power system to the seat-back display

o   Entertainment systems - seat-back displays

o   IFC Antennas and Radome Systems – The antenna systems that allow flight crews to communicate with ground control and passengers to connect to wifi and the associated enclosures to protect these antennas

o   Data systems found in the cockpit

·         The primary driver of this subsegment is in-seat power systems in which the Company has 90%+ of total market share. The Company sells its in-seat power systems for both retrofits and new builds

·         The Company offers several in-seat power options including a full size electrical outlet, a more budget-friendly USB outlet, and more recently, a wireless charging pad

·         In-seat power, and IFEC more broadly, is increasingly being viewed as non-discretionary by airlines because of customer’s demand to have the ability to charge their devices in flight

·         Budget airlines are increasingly adopting in-seat power in new builds, and we think it is not unreasonable to expect that every aircraft seat will eventually have some sort of in-seat power system

·         Approximately 60% of wide-body aircraft seats and 20% of narrow-body aircraft seats currently have some sort of in-seat power, and we believe the Company still has significant whitespace to continue to sell its products for retrofits

·         The in-seat power systems business has a high barrier to entry. User bgm772 articulated this point very well in their write-up on the Company, and I will paraphrase their commentary on the matter. There are only 2 line-fit options for in-seat power: ATRO and KID systems, owned by Airbus. Line-fit means they are FAA and OEM certified to be installed on the factory line by Boeing and Airbus.

·         In-seat power is selected by the airline, not the manufacturer, and airlines will typically use Astronics’ solutions over competitors even though they are more expensive because:

o   Its much simpler for airlines to manage repairs and replacements with one system rather than multiple different ones across the fleet

o   Lessors won’t accept planes returned back to them with aftermarket modifications on them

o   Line-fit equipment can be paid for out of an airlines capex budget whereas aftermarket equipment is included in opex and hits margins

o   Astronics’ system is more aesthetically pleasing

Aircraft Lighting & Safety

·         Aircraft Lighting and Safety makes up about 24% of the Company’s revenues

·         Products in this subsegment include interior and exterior lighting, Passenger Safety Units (PSU’s), and other safety fixtures around aircraft such as exit signs

·         Astronics currently supplies the PSU’s for Boeings 737 and 777 and just won its first PSU contract with Airbus on the new A220

Flight Critical Electrical Power

·         Flight Critical Electrical Power products currently make up about 6% of Astronics revenues.

·         The segment focuses its product offerings on small aircraft (think Pilatus PC-24, Boeing MQ-25 Stingray, etc)

·         This segment is poised for significant growth as Astronics has been contracted to supply the electric power distribution system for the Bell V-280 Valor, the next-generation helicopter set to replace the UH-60 Black Hawk under the Future Long-Range Assault Aircraft (FLRAA) program.

·         There are an estimated 2,000 helicopters set to be replaced in the U.S.’ fleet alone (not to mention foreign buyers) and Astronics has north of $1m worth of content on each aircraft.

·         The Company will not see meaningful revenues form this program for at least 4-5 years, but once the production is underway, we expect the program to generate $200m+ of revenue annually for a decade

·         The FLRAA program alone has the power to significantly diversify the Company’s revenues towards military from commercial and will help the Company diversify away from the volatility seen in commercial aerospace

Recent History

·         From 2010-2014 the Company experienced a significant ramp in sales from doing $195m in revenue in 2010 to over $660m in 2014. This growth was driven by 2 acquisitions, Peco (PSU’s and other interior safety products) and the Company’s test systems business along with an overall recovery in commercial aerospace following the great recession fueled by low interest rates, increased travel demand, and the introduction of new, more fuel-efficient engine platforms.

·         Earnings peaked in 2015 at the tail end of the aerospace upcycle with the Company recording $126m of EBITDA. In 2016 and 2017 the aerospace market hit a speed bump as Boeing and Airbus were introducing the new 737 MAX and Airbus 320neo and production rates slowed. This softness in the aerospace market coincided with some difficulty in recent acquisitions the Company made (Armstrong Aerospace, AeroSat, and CCC). These 3 businesses only generated $50m in revenue in 2017 but had a combined operating loss of an incredible $35m. Yes, you heard that right, $35m in operating losses. Without these 3 businesses, we estimate Astronic’s EBITDA in 2016 and 2017 would have been around the $125m mark achieved in 2015.

·         In 2018 revenues picked back up with a general recovery in the aerospace market along with the acquisition of CSC, but EBITDA margins remained mediocre as the issues with the 3 money losing businesses continued. Operating losses totaled around $35m again for those 3 businesses.

·         In 2019 revenue and earnings took a significant dip as Astronics has significant exposure to 737 build rates and production halted on the 737 MAX because of multiple crashes. Operating losses from the 3 troubled acquisitions continued and totaled around $32m for the year.  

·         2020 – 2021 should be pretty self-explanatory but ordering fell of a cliff and supply chain issues were rampant. The Company experienced operating losses in both years, but orders and backlog began to pick up in the second half of 2021 and the Company was starting to see a light at the end of the tunnel

·         In 2022, demand for all things commercial aerospace soared and the Company began receiving orders at a pace near pre-pandemic levels. Unfortunately, inflation and a broken supply chain prevented Astronics from making any money. The Company typically sells on fixed price contracts that typically last from 1-3 years and they had difficult time passing on increased costs to their customers. Additionally, the aerospace supply chain is EXTREMELY rigid as parts need to be certified by authorities before they can be used. The Company had an extremely difficult time sourcing components and raw materials and didn’t have many alternatives because of the stringent certifications required of parts used.

·         In 2023, the Company is still dealing with supply chain and pricing issues but the worst of it seems to be in the rear-view mirror. In Q2 2023, the Company posted revenues of $174.5m and EBITDA of $15.8m, significant improvements over the $129.1m of revenue and $1.2m of EBITDA in Q2 2022 and $156.5 of revenue and $6.1m of EBITDA in Q1 2023.

The Future

·         We believe that the next 3-5 years will look a lot similar to the 2010-2015 period for a few reasons:

o   Massive tailwinds in commercial aerospace: Ordering and Backlogs at Boeing and Airbus are robust. Boeing currently has enough planes in backlog to fill 7 years of production. Demand for planes from emerging markets is India is strong. India is planning on building 200+ airports in the next 5 years and the country right now only has 700 planes in total (for reference, Southwest airlines alone has over 700 planes). We expect this aerospace upcycle to last well into this decade.

o   Restructuring of money-losing businesses: While management hasn’t provided much commentary on the 3 businesses operating at a loss since the start of the pandemic, we believe these problems have been dealt with as CCC has consolidated into Armstrong and the Company closed and consolidated facilities related to these businesses

o   New program wins: While the FLRAA program wont generate meaningful revenues for the Company for the next few years, we believe the value of the program will slowly be reflected in the stock price as we get closer to the start of production. Again, this program should generate at least $200m in additional revenues for the Company once the production ramps. The FLRAA along with a multitude of other program wins including the PSU contract on the A220 should drive future revenue growth

o   Return to high-teens EBITDA margins: With the losses of the 3 problem acquisitions behind them and the reset of pricing on long-term contracts, we believe Astronics is more than capable of achieving high-teens EBITDA margins again sometime in 2024. 35%-40% of incremental sales on products going forward should flow right to the bottom line. The Company has a relatively high fixed-cost operating structure with a significant amount of fixed R&D and engineering costs embedded within COGS. With a robust backlog and improving supply chain, we should see the Company’s operating leverage in full display over the coming quarters.

Valuation

·         We believe an appropriate multiple for an average quality aerospace components supplier is 11x-13x.

·         On $125m of EBITDA, we believe the Company should have an enterprise value of around $1.5b, still well below its historical high $2B market cap in 2015. This would indicate a stock price more than 2x where the Company is trading at today.

·         If the Company can achieve $1B of revenue and $180m of EBITDA, numbers we think are very reasonable, we believe an appropriate EV would be north of $2B. This represents a stock price more than 3x of where the Company is trading at today.

Catalysts

·         Continued strong orders at Boeing and Airbus

·         Ramp in Boeing and Airbus production rates

·         Supply chain pressures continue to ease

·         Pricing on new contracts resets over the coming quarters to account for recent raw material and labor inflation

Risks

·         Pricing on contracts is relatively fixed so if raw material inflation spikes again, Astronics will have to eat much of the increased costs

·         Moderate to severe recession causing airlines to defer deliveries or cut back on IFEC spend on new aircraft

Catalyst

Continued positive momentum on revenues and margins