ATRO - Astronics Profits Still Come Down To Commercial Segment

2023-06-05 00:06:46 ET

Summary

• Protests have been resolved around the Bell Textron contract for a new generation of FLRAA helicopters to one day replace black hawks.
• The VTOL complexity will probably mean Astronics will occupy a decent proportion of the manufacturing cost, and the upper limits of the contract values are reasonable.
• Still, we think the market has now priced in these developments properly, and the major earnings growth is going to be focused on the larger commercial segment.
• ATRO should be able to churn out some profits, but even assuming incremental sales growth from incoming contracts and saving initiatives, PEs at the current prices are above premier peers.

Astronics ( ATRO ) produces power and other electrical systems for commercial and military aircraft. It depends meaningfully on new volumes of aircraft manufacturing, mostly in the commercial segment which is by far their largest segment. Military has been a weaker spot due to a come-down from 2021 results, but in Q1 2023 they are stabilising and the denial of a protest against the award of a new FLRAA contract to Textron ( TXT ), who are subcontracting Astronics, new military revenue should be possible in the coming years as these FLRAA VTOLs start replacing the important US and US-ally Black Hawk fleet. The protest denial was an event that helped the stock price recover, and since there is a limit to how large ATRO's piece will be, we think the effects are priced in. Therefore, at this point investors need to consider new manufacturing volumes to drive scale economies and profits. While we have some confidence in new plane volumes, we still think the slim margins make the company unattractive.

Q1 2023 Comments

The major growth segment was in commercial, with revenues up 50%. Marginality is improving substantially thanks to scale economies, and the sector is the more profitable one to begin with. The company was operating level unprofitable in 2022, and continues to struggle in Q1 with negative operating margins. With restructuring programmes alone on the cost side, margins should become positive even assuming no incremental revenue growth by Q3 (est. $5 million in cost savings annually).

$5 million of annual costs with savings being evident in the third quarter this year after severance costs are finished

Peter Gundermann, CEO of ATRO

We also have more information on the test segment contract related to radios, which should begin making its revenue contributions in 2024. The incremental revenue growth from that should be around 10% at 2022 revenues, more likely around 5% at 2024 revenues assuming the normalisation of sales to pre-COVID levels plus the new contracts.

A smaller contract with the USMC for portable radios could be another similar contributor starting already in 2023 .

The major development has been the denial of protest over the Textron FLRAA contract award for the V-280s, where ATRO is subcontracted. The size of the contract is still unclear, as it depends on the pace of replacement of Black Hawks by the US and allies. The global fleet is around 4000 Black Hawks , and each V-280 is expected to cost around $43 million . Lockheed Martin ( LMT ) were the ones protesting since they own Sikorsky which services the Black Hawk fleet. The initial batch order could be around $230 million, but if the project is a success it could be as large as $70 billion, consistent with around a full replacement of Black Hawks by the US Army.

ATRO won't disclose how large their stake in the contract is, but it could be as much as little as 5% of the contract value or even as high as 20%, considering that they are involved in power distribution systems, which are not likely to be commodified since the V-280 has a relatively complex propulsion system that could require a lot of advanced power distribution and because they are likely to be developing a new system for the V-280. It really depends on how valuable the ATRO contribution is, which we cannot know. See the sensitivity analysis below, where we assume the project value is paid out in 10 years starting in 2030 . The success of the overall project will be essential, but also consider that it may take much more than 10 years to fully pay out, since Black Hawks have lasted so long and can go a bit longer. We are going to err on the side of caution here and assume the contract will have a lesser rather than greater contribution, especially since the current ATRO profits and multiple aren't particularly compelling.

This programme will take decades. Considering military is only 10% of revenues, the overall effect is likely to be limited on stock price for now, especially considering the commercial push for the programme is only expected in 2030.

Bottom Line

In the end, ATRO's fortunes are going to come down to the commercial aviation segment. In our last article we made the case that carrier fleets are getting older and smaller , and the resurgence in travel is going to require some aircraft manufacturing. The only trouble is that major manufacturers may struggle to keep up with demand due to ongoing supply chain issues, specifically Boeing ( BA ) which is a major ATRO customer. With recessionary pressures also a concern, as carriers may decide to tighten their belts as retail trends deteriorate where idiosyncratic rebounds in travel may not be enough of an offset, ATRO's commercial segment is not likely to be especially recession resistant in the longer-run. Overall, they remain unprofitable. And even with the various sources of incremental revenue growth, PEs will still be at least in the high-teens in terms of multiple which is consistent with the valuation of premier defense companies like Lockheed at around 16-17x. There isn't much of a reason to go into ATRO for a higher valuation than other major defense players, since they also may have opportunities as big as the FLRAA deal than ATRO which is a more marginal player.

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