Description

VSE Corporation (VSEC) is an undervalued “mini-conglomerate” with several strategically valuable aftermarket businesses whose value is not appreciated by the market.  The company has historically been undermanaged and underfollowed.  VSEC is well-positioned to create significant value over the next several years with a new high quality CEO.

VSEC is a $473MM market capitalization, $675MM enterprise value diversified service and supply chain management company that aids clients in sustaining, extending the service life, and improving the performance of their transportation equipment, other assets and systems.  VSEC provides logistics and distribution services for legacy systems and equipment and professional and technical services to the U.S. Government including the Department of Defense (DoD), the U.S. Postal Service (USPS), federal civilian agencies and commercial customers.  VSEC’s largest historical customers have been the DoD as well as the USPS.  Operations include supply chain management solutions, parts supply and distribution, and maintenance, repair and overhaul (MRO) for vehicle fleets, aircraft, systems and equipment.

The investment thesis for VSEC is based on the following points:

1.      VSEC is an attractive value – trading at 8.2x “depressed” LTM EBITDA and at an enormous discount to any reasonable SOP analysis.  The stock is undervalued on LTM numbers and is likely to see a meaningful rebound in their Aviation segment as airline miles traveled increase. Using discounted multiples in a SOP analysis points to immediate upside of $55 to $61.  The key point is this – from a depressed starting point using LTM numbers - comparable valuations imply 45-62% immediate upside and reasonable forward looking assumptions point to a potential double in 3 years.

2.       VSE has robust and established market positions supporting mission-critical applications that have sustainable and enduring value.  VSE is the type of business that if a buyer purchased and closed his or her eyes for a decade – absent gross mismanagement – the business would still be producing cash and a reasonable ROIC ten years later.  These are sustainable, 100% aftermarket businesses with low risk of obsolescence, minimal capital intensity, with upside optionality due to the currently depressed nature of the Aviation business and M&A opportunities.

 3.      VSE has a strong CEO with a history of value creation.  VSEC CEO John Cuomo took the position on April 15th, 2019.  John previously served as the VP and General Manager of Boeing Distribution Services.  He joined Boeing through the acquisition of KLX Aerospace, where he served as General Manager of the business.  The history here is that the business was spun-off from B/E Aerospace, grown successfully and profitably, and then sold in a home run transaction to Boeing.  Boeing acquired the business in May of 2018 for $4.3B, equivalent to 15.7x trailing EBITDA and 14.3x estimated 2018 EBITDA.  Cuomo, 46, held multiple positions at KLX/BE for 14 years but he ran the Aerospace Solutions business its entire time as the primary subsidiary of a public company from 2014 through 2018.  He was responsible for the acquisition and integration of 10 different businesses with a combined value of $1.5B.  Our primary research checks on Cuomo were outstanding – "strategic thinker, strong leader, understands numbers, robust analytical skills."  Historically VSE has been an orphaned security.  They have had minimal institutional coverage and held no conference calls.  VSEC has begun to conduct quarterly conference calls and increase shareholder outreach.  Strategically, Cuomo wisely divested the company’s Prime Turbines & CT Aerospace subsidiaries and has built out a strong management team.  The company has signed several high quality distribution deals with OEMs in the Aviation segment, has sharpened their bidding process in the Federal business, and has grown their non-USPS business significantly within the Fleet subsidiary.  In January, VSE raised $50MM in a secondary due to the fact that Cuomo sees multiple acquisitions in the Aviation area.  I expect significant top and bottom line growth through both organic growth and M&A over the next several years.

Business Summary

VSE Corporation helps customers maintain their assets through core offerings in supply chain management, MRO equipment refurbishment, logistics and engineering.  The company also provides IT solutions and energy consulting services.  VSE manages the business through three separate segments:  The Aviation segment accounted for 26% of LTM revenues and 18% of EBITDA, the Fleet segment accounted for 33% and 49% and the Federal & Defense segment accounted for 42% and 33%.

Aviation - The Aviation segment generated $170MM in sales and $14.5MM in LTM EBITDA.  For perspective, in 2019 the segment generated $226MM in revenues and $30.3MM in EBITDA.  COVID-driven softness has masked underlying growth and share gains.  In fiscal 2019, the segment increased revenues 54% and 11% on an organic basis and 1Q20 (pre-COVID) Aviation generated 18% organic revenue growth.  The segment has outperformed industry numbers and maintained profitability throughout the downturn.  Aviation provides parts supply and distribution, supply chain solutions and maintenance, and repair & overhaul (MRO) services for commercial and general aviation jet aircraft engines and engine accessories.  The group offers a range of complementary services and supplies to a diversified base of commercial airlines, regional airlines, cargo transporters, MRO integrators and providers, aviation manufacturers, corporate and private aircraft owners and some agricultural clients.

The Aviation segment is divided equally between MRO and Distribution.  The business is 100% aftermarket so it is uncorrelated to OEM production – an enviable market position for the next several years in my view.  Below is a summary of some of the segment’s subsidiary operations:

Repair:

Ø  1st Choice Aerospace – is a FAA/EASE Part 145 Repair Station with locations in Miramar, Florida and CVGI/Hebron, Kentucky focused on high-temperature, high-flow pneumatics, fuel, electronics and electromechanical accessories, crew seats, O2, cargo and waste systems for commercial, cargo and military aircraft.

 Ø  Kansas Aviation – this group specializes in the overhaul and repair of oil, air and fuel-related engine accessories on the P61, PT6TPW100, PW150, PW300, JT15D, CJ610, CF700, Allison 250, CF34 and PW901 engines.  The business is located in Independence, Kansas.

 Ø  CT Aerospace – a leading supplier of engines, engine parts and related services to its customer base.  The group specializes in Pratt & Whitney Canada Pt6A, Pw100, JT15D, PW300 and PW500 series engines and engine parts.

Distribution:

Ø  VSE Aviation Miami – VSE Miami is an aircraft parts supplier specializing in the distribution of aircraft ignition parts, fuel controls, starter generators and related parts for aircraft turbine engines.  They list over 21K part numbers and stock over 1MM items.

 Ø  VSE Aviation Singapore – A Singapore-based Honeywell Authorized Distributor for commercial aircraft material, primarily serving Asia-Pacific.

 Ø  VSE Aviation Germany – VSE Germany is an independent EASA, FAA and Transport Canada.

Aviation recently announced two new significant distribution agreements.  On October 27th, VSE announced that they will be the exclusive distributor for over 150 line-replaceable units and 1,600 landing gear accessories supporting current in-production Boeing and Airbus platforms.  Additionally, on January 28th the company announced that they entered into an exclusive, “life of program” agreement with Pratt and Whitney Canada as the exclusive global licensed distributor for new radial parts and inventory of P&W Canada’s APS500 Auxiliary Power Unit for commercial applications.  The one downside of these new agreements is that they are a drag on cash as they require inventory investment.  As this business has grown over the last five years inventories have been a significant drag on free cash flow.  That noted, between a strong rebound in passenger miles flown, new product agreements and likely tuck-in M&A, Aviation is poised for significant multi-year growth.

Fleet – The Fleet Segment (Wheeler Brothers) generated $215MM in LTM revenues and $38.4MM in EBITDA.  The segment provides sourcing, acquisition, scheduling, transportation, shipping logistics data management and other services to assist clients with supply chain management.  Wheeler Brothers supports the USPS, commercial truck fleets and the DoD with fleet management, sustainment solutions and managed inventory services.  In aggregate, Wheeler supports and maintains over 250K light, medium and heavy duty trucks across the U.S. and their warehousing facilities ship over 4MM items annually to over 600 locations.  The business is dominated by a 50-year relationship with the USPS where VSE manages the inventory of parts necessary to maintain the USPS fleet.

Historically the Fleet segment has effectively been all USPS, but now has diversified to the point where over 20% of revenues are non-USPS.  Of note, in the third quarter the segment experienced 107% growth in ecommerce fulfillment and total “non-USPS” revenue growth was 54% year-over-year, supporting commercial fleets and government customers.  End customers outside of the USPS including sanitation companies, 3PL companies, school buses, and other commercial fleets.  Below are some of the primary service offerings of the segment:

Ø  Inventory Management – Wheeler offers a complete managed inventory program that ensures their customers’ maintenance facilities are optimally stocked with parts.  This enables customers to cut fleet downtime, cut obsolescent inventory and reduce parts inventory carrying costs.

 Ø  Fleet Management Software – VSEC provides a full, end-to-end service platform for fleet-based companies of all sizes.  The software incorporates automatic scheduling by mileage or time, a customizable web-based interface tailored to customer needs, delivers parts usage updates, repair center management, part number tracing on vehicles to track recall or warranties, automatic stockroom replenishment and other services.

 Ø  Stockroom Optimization – VSE offers services in analyzing storerooms, supporting procedure and optimizing inventory management practices.  This leads to lower stock-related carrying costs, obsolescence and waste.

 Ø  Research & Engineering – The company works with customers to identify opportunities for continuous improvement in a vehicle’s life cycle and to reduce maintenance costs.  The company can research and engineer hard to find spare or replacement parts for any fleet

 Ø  Defense Support – Wheeler supplies the DoD with quality, mission-critical automotive parts in supply of the Warfighter.  Their government sales department has over 30 years of experience in engineering, research and contract administration.

As noted earlier, the growth strategy for Fleet is focused on commercial.  Management believes that they are uniquely positioned to provide stocking distribution services and JIT parts delivery to a wide range of high-duty and vocational fleet owners.  Inventory management and e-commerce fulfillment for new commercial customers is the main avenue for growth.

Federal & Defense – VSEC’s Federal & Defense segment generated $277.6MM in revenues and $26.5MM in EBITDA in the last twelve months.  The segment provides foreign military sales services, refurbishment services to extend and enhance the life of existing vehicles and equipment, fleet-wide ship and aircraft support, aircraft sustainment and management, engineering, logistics, configuration management, prototyping, technology and field support to the U.S. Navy and Marine Corps, U.S. Army and Army Reserve, US. Air Force and other customers. 

VSE’s Federal & Defense segment is a traditional government contracting business that is focused on asset management and logistics, similar to their other segments.  Specific services provided include supply chain management, MRO, engineering services, training, professional IT services and energy management consulting.  Below are some of VSEC’s major programs:

Ø  Foreign Military Sales – VSEC provides assistance to the U.S. Navy in executing its Foreign Military Sales (FMS) program for surface ships sold, leased or granted to foreign buyers

 Ø  Red River Army Depot Equipment Related Services Program (RRAD ERS) – this program provides on-site logistics support for the Red River Army Depot at Texarkana, Texas.

 Ø  Fort Benning Logistics Support Services Program – This contract provides support for base operations as well as logistics at Fort Benning, Georgia.

 Ø  U.S. Army Reserve Vehicle Refurbishment Program – VSEC provides vehicle refurbishment program and various vehicle and equipment refurbishment, maintenance and sustainment programs for U.S. Army commands.

 Ø  Contract Field Teams (CFT) – the CFT program provides rapid deployment and long-term support services for the maintenance, repair and modernization of aircraft, vehicles, weapons systems, and other equipment to support readiness needs.  Currently VSEC is most focused on providing support to the U.S. Air Force.

Valuation/Financials

I am currently modeling $84.5MM in fiscal 2021 EBITDA with growth to $117MM in 2024 driven by both organic growth and M&A.  This translates into 2024 adjusted EPS of $4.72 per share.  An exit at 10x consolidated EBITDA implies $74.67.  This implies a conservative target PE ratio of 15.8x EPS. 

Pro-forma for the recent equity raise VSEC has approximately $48MM in cash and $250MM in total debt.  This equates to 2.4x net debt to EBITDA on my 2021 estimate and 2.6x LTM adjusted EBITDA.  The company has total credit availability of $350MM. 

Below are three different comparable tables for VSE’s three divisions. 

Below are M&A comparables for the company’s three divisions:

Management

CEO John Cuomo is a significant positive factor of the investment thesis.  Cuomo joined the company in April of 2019 from Boeing where he served as VP and GM of Boeing Distribution Services.  Prior to Boeing’s 2018 acquisition of the Aerospace Solutions Group of KLX, Cuomo served as its VP and GM, Consumables Management business from 2014.  From April 2000 to 2014, he served in multiple roles and functions at B/E Aerospace including VP and GM & SVP, Global Sales, Marketing & Business Development.  Before joining B/E, he served as an attorney focused on commercial law, mergers and acquisitions and litigation.  John has largely built out a new management team over the last two years.  CFO Steve Griffin joined the company from GE where he served as the CFO of Engine Services at GE Aviation.  Earlier in his career he served as CFO for GE’s Aviation’s Supply chain division.  Ben Thomas is the President of Aviation Solutions.  He worked with Cuomo at KLX and Boeing and managed aftermarket growth strategies in the consumables division.  Rob Moore is the head of Federal & Defense.  He joined the company from S&K Technologies where he was head of Business Development.  Prior in his career he was employed by DynCorp, PAE, BAE Systems and ARINC.  Chad Wheeler, head of Fleet was the only legacy division head that remains.  There are several other management team members who have worked with Cuomo in the past.  I consider this a positive signal.

Risk Factors

There are multiple risk factors to an investment in VSEC:

Ø  The company has a relatively levered balance sheet

Ø  VSE has significant exposure to the USPS which has well documented financial issues

Ø  The thesis relies on successful M&A execution – which implies execution risk

Ø  VSE has significant government contract and bidding exposure

Ø  Free cash conversion has been pressured due to consistent inventory builds.  This is likely to continue in the near-term

Catalyst

- Rebound in Commercial Aviation miles flown

- M&A