Description

Summary: Northstar Aerospace is a Canadian Aerospace company that is very profitable and has recently finished a 2 year restructuring program. It trades at 4.2 P/E and 3.5 EV/EBITDA on 2003 estimates 5.7 P/E for 2002). It has $59 million of tax loss carry-forwards and will generate $30 million of free cash(after capex) in 2003. This free cash will be used to pay down the debt of $100 million. The company is also finalising the search for a new CEO.

Northstar, previously called Derlan Industries, was founded in the 1980s. After several problems, the Board replaced the founding Chairman and undertook a restructuring program. Asset sales were used to repay debt and focus the company on aerospace drive systems (gears and transmissions). After acquisition of a small Chicago plant from Boeing and Windsor Gear, a Canadian manufacturer, the company undertook a marketing drive. Primary wins were a major contract for 150 Apache helicopter transmission sets and an extension of a GE contract for gearboxes for Bombardier regional jets.

As a result, Northstar is sole supplier on several key military programs including Apache AH64 and Lynx helicopter, the F-22 Raptor and the CH-46. Military sales are 60% of total sales of which Boeing is 60%. Of the balance, about 25% of sales are for use in Bombardier's regional jet program and the remainder is Boeing 767's and Airbus 300s auxiliary power units. Northstar also has a pump business, which it carries as a discontinued item - if unable to reach some agreement with the Mexican partner, it will probably write off the $13 million investment at year-end.

There are two primary risks to this story. One is obviously the aerospace business - however, the defence focus mitigates this to a great extent. It is likely that Northstar will repeat its win on Apache with further contracts. The MRO market is also attractive.

The other primary risk is to Bombardier regional jets, in light of major airline troubles. It seems that the regional jet market is much less impacted than the major routes flown by bigger Boeing/Airbus planes. In addition, Bombardier seems to be very serious about fixing its shop with the recent lauded replacement of top management.

Northstar trades at 30% of the valuation of the smaller US defence companies. Admittedly, it is a small cap and not a pure play and will always have a discount. However, there is considerable growth potential since the utilisation in Canadian plants is less that 75% and less than 60% in Chicago. In addition, the company is planning to move it's head office to Chicago to better tap the US defence market and to be close to Boeing, a large customer.

Catalyst

Two Canadian private equity groups have been instrumental in restructuring the company and recruiting new management. Their objective is to optimise value by operating the company over the next couple of years, reduce debt and grow earnings. In all likelihood, the company will then be sold.