Description

Spirit Aerosystems was written up by beep899 at $70.  If you liked the stock at $70, you should really love it at $19 and by extension the bonds.  I’m not going to rehash that write up here.  In one sentence the company makes fuselages, propulsion systems, and wing systems for primarily Boeing and also some Airbus.  The Boeing 737 MAX was expected to be 50% of revenues this year.  In the last couple weeks, we have had some major events that I think make Spirit well worth revisiting here. I think the bonds are going to be money good and I recommend all maturities of the bonds- the recently issued second lien 7.5% bonds look like the best risk reward to me, but I really prefer the equity- I just can't write that up because beep899 posted it in December- though I think it is fair to say the story is quite a bit different today and so is the risk reward.

For Spirit to work you have to answer three questions.  1) Can the company make it through the pandemic?  2) Will the Boeing 737 MAX fly again? And 3) Will demand for airplanes return long term?  It is my assertion that you can answer all three of these in the affirmative.

Can Spirit make it through the pandemic?

Based on where the stock is trading, investors are clearly worried about whether Spirit can make it through the crisis.  

Let’s have a look at the balance sheet.  Spirit ended the year with $2.35 billion in cash on hand and debt of $3.034 billion.  This doesn’t seem particularly excessive for a company that did $690 million in FCF last year.  

The company closed the acquisition of FMI for $120 million in January.

The company had pending acquisitions of ASCO for $400 million and Bombardier’s maintenance and other businesses for $500 million + a $130 million pension contribution.

On April 17 Spirit issued $1.2 billion of second lien notes with a 7.5% coupon and that is the bond referenced in my write-up. They are currently trading at $95.67 with a YTM of 8.6%. Given their place in the capital structure I expect these bonds at the very least to own the SPR equity if the company has a problem, but I don't think there will be a problem at all.

So the present situation is:

Cash on Hand: $3.4 billion less any Q1 cash burn.

Op ex outside of COGS is only $311 million per year.  So if they aren’t making planes the burn just isn’t that fast.

Total Debt: $4.234 billion.

ASCO deal expected to close by October.

Bombardier deal was originally expected to close by the end of June, not sure if that will change or not.

So we are looking at $2.4 billion to get the company through once all the deals close.  

In terms of the maturity profile we have:

Senior Unsecured Term Loan A (2023 for balance with $2.3 million per Q) - $416 mil

Revolver 2023 - $800 mil

Floating rate notes 2023 - $300 mil

2nd Lien Notes Due 2025 - $1,200 mil

Senior Notes Due 2023 - $300 mil

Senior Notes Due 2026 - $300 mil

Senior Notes Due 2028 - $700 mil

So these notes are spread out pretty far.  Meanwhile, we have a company that was able to raise $1.2 billion on short notice with a high yield of 7.5%, but they got it done.  Bottom-line, assuming they can get back to work sometime in the next few months this company is going to be fine.  Production will likely resume at a low level before all of these acquisitions close, so the present liquidity buffer is pretty significant.

Boeing already announced they are resuming production in Seattle as of April 17th so non-max plane production should be coming back online.

The real question as an owner of Spirit is does Boeing survive?  I think the answer is an unquestionable yes.  We worked out a government funded pre-packaged bankruptcy of GM during the great financial crisis and that company is much less strategically important to the U.S. than Boeing which owns a critical defense business.  So as sheepish as I am to say it, there is also a Boeing put here.  Boeing can’t make planes without Spirit.  Therefore it must be sure Spirit survives.  While I understand Boeing may get bad terms from the U.S. Government if it needs a loan including having to give up an equity stake, the truth is Spirit isn’t Boeing.  Boeing would probably offer Spirit support with some of its government proceeds if needed.  I’m doubtful that it will require equity to do so. Bottom line, I think there is a U.S. Government put under Boeing and I think Spirit shareholders are much less likely than Boeing’s to get diluted if that put is exercised.

An additional positive came recently as Airlines have received their “bridge capital” - with no equity dilution.  While I’m sure the Boeing backlog of 5 years is going to decline, once this virus clears there are still going to be customers around to buy planes as air travel slowly comes back.

So does Spirit make it?  I think they do.

Will the MAX be recertified?

With respect to the question of will the MAX be recertified, as of March 2, the FAA was saying the MAX recertification test flight was “a few weeks away.”  https://www.travelpulse.com/news/airlines/faa-says-boeing-737-max-certification-flight-a-few-weeks-away.html

So even if COVID delays it by 8-10 weeks we are probably on track to be recertified by July or August.  

Beep889 had a lot about why the MAX will fly again, so I’d certainly point you to that discussion.

The New York Times laid out a nice summary of what needs to happen for the MAX to fly in this article: https://www.nytimes.com/2020/02/10/business/boeing-737-max-fly-again.html?partner=bloomberg

It is clear to me that the MAX will fly again, it is just a matter of when.  I think Spirit will rally once the MAX is recertified.  Given that this could be within a few months, I think now is a good time to make an investment.  

Will air travel and long-term demand come back?

Now we come to the highly subjective bigger question of what COVID-19 does to air travel demand longer term.  It is my assertion that, for the most part, demand for air travel will return to pre-COVID levels over a number of years.  Why do I think this?  Look no further than Asia.  SARS in 2003 was super scary.  It was significantly more deadly than COVID-19.  Yet air travel came back to it’s prior levels six months after the crisis had passed:

https://www.iata.org/en/iata-repository/publications/economic-reports/what-can-we-learn-from-past-pandemic-episodes/

Look at 9-11-2001.  Passenger planes were literally turned into bombs.  You can’t make flying more scary than that.  Nonetheless, air traffic returned to prior levels by July 2004 despite that very scary event (albeit with air marshals and reinforced pilot cabin doors):

https://www.bts.gov/sites/bts.dot.gov/files/legacy/publications/special_reports_and_issue_briefs/issue_briefs/number_13/pdf/entire.pdf

So humans have shown a consistent capacity to have relatively short memories when it comes to fear of flying due to scary events.  And sure you can argue that more business meetings will be virtual, etc.  But if you are like me, an in person meeting is still way better than a Zoom meeting.  Sure Zoom works, but it isn’t ideal.  And I think when things are safe people return to pursuing for the ideal.  Think about sales.  Maybe people conduct sales by Zoom for a little while after this.  But, eventually, a few brave souls decide they can get an edge by doing in person meetings again, and soon everyone else must follow.

Valuation

In terms of valuation, assuming the company can earn even what it did in 2019 (with slower production due to MAX grounding) the company can earn $5.20 per share when business gets back to normal.  Assume that it trades at 12x at that time. You are looking at a $62 stock.  If the airline business comes back in a more meaningful way and the 737 MAX delivers anywhere near what people thought it could in peak years this business could earn $8 and easily be a $100 stock.  Even if that takes 3-5 years, that is a pretty good return from here.  Note that I put the 2019 numbers in the 2021 estimates, just so you have a sense of the normalized earnings potential of the business and because any estimates I provide for 2021 are going to be largely worthless given the event-driven nature of this story.  I think the bonds will all prove to be money good.

Catalyst

737 MAX recertification by this fall.

Air travel slowly coming back.