Description

Investment Thesis

Magellan is a global aerospace supplier headquartered in Canada and focused on aerostructures. The company will benefit from the ramp in commercial aircraft production over the next few years as well as the normalization of supply chain conditions and cost inflation. EBITDA averaged $156 million over the five years prior to covid against a current enterprise value of $490 million including capitalized leases (3x normalized EBITDA). The FCF yield at normalized EBITDA levels should be in the 15-17% range and I would expect this level of EBITDA could be achieved in the 2025/2026 timeframe. At a 10% FCF yield (5.3x EBITDA), this would be a $13-$14 stock (+86%).

Downside on Magellan is well protected with TBV at $11.75, NWC per share of $6.00 and no significant cash burn even through covid. The balance sheet is clean with less than half a turn of debt on depressed EBITDA. Magellan is 75% owned by CNQ Executive Chairman and Member of the Order of Canada Murray Edwards with another 5% owned by Murray’s friend, Larry Moeller. They behave like a private company with minimal disclosure, no conference calls, and no investor marketing. The company really should be private, though Edwards has been content to leave the public stub outstanding since he took majority ownership during the financial crisis.

Magellan’s Business and Valuation

Magellan has 19 operating divisions located in North America, UK, France, Poland, and India. Magellan’s business has historically been about 70% commercial/30% defense with the commercial piece currently depressed. On the commercial side, the company is overweight Airbus vs. Boeing, in part due to Airbus’ higher current production rates. Magellan would benefit from a ramp in widebody production as the larger aircraft tend to carry higher margins. On the defense side, Magellan is weighted to MRO work in the US and Canada which management expects to be flattish. Management expects some growth in the defense business in late-‘24/early-’25 from a new Raytheon missile fin contract and has content on the joint strike fighter program.

Magellan is an average business with after-tax returns on tangible capital in the high-single digits/low double-digits pre-covid. Significant supplier power constrains returns. The company delivered solid financial results pre-covid as a result of consistent execution and disciplined capital allocation, growing TBV per share from $7.71 in 2015 to $12.33 in 2019 while paying $1.50 in cumulative dividends (16% CAGR including dividends). Magellan’s share count has trended down modestly over time as the company has a small NCIB that is active when the shares are below $7.50 and the last major acquisition was in 2015 for $56 million. Aside from that acquisition, FCF has been used to reinvest in the business and retire debt, leaving the company with leverage below 0.5x today on depressed EBITDA.

From 2015-2019, Magellan averaged $156 million of annual EBITDA and adjusted EPS of $1.39. Management guides to normalized capex of ~5% of revenue (including some for growth) which would equate to ~$50 million if revenue recovers to the pre-covid range. With $5 million of lease payments and an allowance for taxes, unlevered free cash flow could be in the $75 million range on a normalized basis for a FCF yield in excess of 15%. Given the robust long-term outlook for commercial aerospace, I would see the potential for continued growth from this normalized level.

Has something structurally changed with the business or industry such that Magellan will be unable to return to the normalized pre-covid level of profitability over the next few years? Management is framing the recovery in profitability as depending on three factors: (i) normalization of supply chain conditions, (ii) inflation stabilization/reset in contract pricing, and (iii) better overhead absorption on the continued recovery in commercial aircraft production.

Supply chain normalization seems to be tracking well. Absent any macroeconomic issues, overhead absorption from increased production volumes also seems like a matter of “when” not “if”. Inflation stabilization/contract pricing is the piece of the profitability recovery story that seems most at-risk. Management says that while they have some life-of-program contracts, pricing is renegotiable every five years. Many contracts would be shorter than that in duration (CFO could not tell me their average contract duration). Further, management is engaging in conversations with suppliers to ask for better pricing during the contract terms. So far, management says these conversations have borne limited fruit. The company also has a few larger union contracts up for renewal early next year which will drive further cost increases on the labour side. I am betting that through a mix of falling inflation and price renegotiations, Magellan will ultimately return to historic levels of profitability...or at least get close.

Magellan stock is inexpensive on normalized earnings (15%+ FCF yield, 5-6x EPS, 3x EBITDA) with good downside protection from TBV and NWC (trades at 0.63x TBV and 1.23x NWC) as well as a clean balance sheet. The stock is also inexpensive on a relative basis. Spirit AeroSystems trades at 6x ’25 consensus EBITDA vs. 3.8x for Magellan (consensus for Magellan is 15% below the pre-covid average). Magellan likely deserves to trade at a lower EBITDA multiple because of the higher capital intensity of its operations. If it were to trade at Spirit’s multiple, Magellan would be a $12.50 stock (+70%).

Catalyst

Continued recovery in revenue and profitability.