Spirit AeroSystems (NYSE:SPR), a onetime Boeing (NYSE:BA) subsidiary and still a major supplier to the aerospace giant, was expected to be among the companies most affected by the grounding of 737 MAX and Boeing’s many other issues. And sure enough Spirit reported third-quarter results well under expectations.
Spirit manufactures the fuselage for the 737 MAX, and thanks to an agreement with Boeing has been able to continue the work even as an investigation into the plane’s troubles continues. But that agreement has not been enough to fully shield the company, which remains highly reliant on Boeing more than a decade after going out on its own.
Management at Spirit had a plan in place well before the 737 MAX had problems to deal with that overreliance, and concurrent to releasing earnings announced a bold move that would dramatically expedite that plan. Here’s where things stand for Spirit AeroSystems today, and where the company hopes to head in the future.
Doing well treading water
On Oct. 31, Spirit reported third-quarter adjusted earnings of $1.38 per share, well short of the $1.68 per share consensus. Net income for the quarter, at $131 million, was down 22% year over year.
A pair of Boeing programs were largely responsible for the fall. Spirit took a forward loss of $33 million, or $0.24 per share, on Boeing’s decision to decrease 787 Dreamliner production to 12 aircraft per month. Spirit also continues to suffer increased costs due to the 737 MAX grounding. Boeing is buying airframes even while the 737 isn’t flying, but the supplier had expected to be ramping up production by now and had put in place the infrastructure to support higher volumes.
The quarter wasn’t all bad. Gross margin, excluding all the quarter’s noise, gained more than 100 basis points sequentially and was higher than the same three months of 2018, before the 737 MAX troubles kicked in. Spirit reported $255 million in cash from operations, up about 50% year over year, and adjusted free cash flow up 68% to $219 million thanks in part to cash advances from Boeing.
Boeing is hopeful to get the 737 MAX flying by early next year at the latest, and the company is standing by its plan to eventually increase production to 57 frames per month from 52. Unfortunately for Spirit, it could now take until 2022 for the supplier to benefit from that hike, as Boeing will initially use the excess inventory it is building up as it continues to purchase from suppliers through the grounding.
All in all, Spirit seems to be making the best of a bad situation, but CEO Thomas C. Gentile during a post-earnings call with investors admitted the uncertainty is likely to linger.
“The entire Spirit organization embraced the challenge to align our cost structure with the lower volumes that the MAX grounding created for this year,” Gentile said. “While we made good progress on cost mitigation actions we must maintain our focus on operational efficiency and quality improvement to achieve our margin targets.”
Getting out of Boeing’s shadow
It didn’t take the 737 MAX crisis for Spirit AeroSystems to realize it is too reliant on Boeing. Not long after the company’s spin out of Boeing in 2005 it attempted to diversify, but in its early years it mostly acquired low-margin and unprofitable businesses that were attractive mostly because they were outside the former parent’s reach. The company went public in 2006 at $26 per share, but saw its value cut in half during the recession as the losses built up.
Spirit AeroSystems in recent years has shed most of those unprofitable businesses, but still gets upward of 75% of its revenue from Boeing. The company last year began a push to expand outward again when it announced plans to buy Airbus supplier Asco Industries for $650 million, and it doubled down on that strategy last week in announcing plans to buy much of the aerostructures business of Bombardier (OTC:BDRAF) (OTC:BDRBF) for $1.09 billion, with more than half the total value made up of assumed pension and other liabilities.
The Bombardier assets to be acquired include 3.4 million square feet of manufacturing space in Northern Ireland, Morocco, and Texas used to make large components for the Airbus A220 and A320neo platforms and Bombardier jets. The business makes metallic wing components, nacelles, fuselages, and tail assemblies, and also has a large aftermarket, or spare parts, business.
Gentile on the call claimed, “We don’t have a goal of diversifying away from Boeing,” noting Spirit’s strong relationship with the aerospace giant and its desire to grow its business there. However, he notes, “we do want to grow some of our other customers faster,” specifically mentioning Spirit’s relationship with Airbus and his desire to grow Spirit’s military content business.
The Bombardier deal, priced at just over 6.5 times the target’s EBITDA after cost savings, seems attractive for the added exposure to Airbus platforms that should be fast growers. And Spirit is generating enough cash to easily manage the $500 million cash payment and $130 million cash contribution to pension at closing.
It’s a smart deal, but because the closing of the Asco purchase got hung up in a European review, Spirit management will face the daunting challenge of integrating both transactions simultaneously while still getting through the 737 MAX grounding and its reverberations.
No need to jump in
Spirit’s attempts to diversify, or whatever Gentile wants to call it, are the correct move, and I have confidence that under this management team the company will not fall into the same trap of bidding for low-margin work or end up in the same sort of mess it was in a decade ago.
That said, for all the good work being done at Spirit AeroSystems, the company has very little control over what becomes of the 737 MAX, and even if airlines do continue to buy the plane after it is recertified, as expected, it is going to take a long time for Spirit to benefit from that added demand. Couple that uncertainty with the risks of integrating two large, global acquisitions, and Spirit AeroSystems seems to have a lot of headwinds in front of it.