SPR - Due To New Issues I Can No Longer Be Bullish On Spirit AeroSystems

2024-01-10 01:05:06 ET

Summary

• Spirit AeroSystems and Boeing face another major quality issue as an Alaska Airlines 737 MAX-9 lost its door.
• The incident raises concerns about the safety of the Boeing 737 Max series and could impact global orders.
• This setback disrupts Spirit AeroSystems' recovery efforts and presents challenges for the company's financial outlook.

Introduction

It's time to discuss some very bad news, as Spirit AeroSystems ( SPR ) is, once again, involved in a major quality issue involving a type of Boeing's ( BA ) 737 model, as an Alaska Airlines ( ALK ) 737 Max-9 lost its door.

Luckily, nobody died.

That said, my most recent article on Spirit was written on October 18, when I went with the bullish title "Spirit AeroSystems Stock Could Surge - But Major Issues Remain."

Since then, the stock rallied 50%, beating the S&P 500's 9% return by a significant margin.

Needless to say, that rally is over now, as SPR shares are down 18% pre-market while I am writing this.

In this article, I'll share my thoughts on the accident, the company's efforts to improve its business, and the risk/reward.

So, let's get right to it!

Another Major Issue For Spirit And Boeing

On Friday, an Alaska Air 737 Max-9 had to make an emergency landing after a door had fallen off the airplane, causing the airplane cabin to quickly lose pressure.

Luckily, nobody died. Although I can only imagine the shock these passengers may have had during the accident, it needs to be said that air travel is one of the safest transportation methods.

According to Anxieties.com (speaking of a good source for these issues):

• The odds of dying in a US commercial jet airliner are 1 in 7 million.
• The odds of dying from a cardiovascular disease are 1 in 2.
• The odds of dying on a coast-to-coast car trip are 1 in 14,000.
• The odds of dying from a bee sting are 1 in 5.5 million.

In other words, while this accident certainly doesn't help the people who already fear flying, there's still nothing to worry about.

That said, SPR and BA shareholders have something to worry about.

As reported by Bloomberg, Boeing's 737 Max, which was initially touted as the safest plane globally, faces ongoing safety concerns almost five years after the second fatal crash led to a global grounding.

Despite the Federal Aviation Administration's assurance of its safety, the recent incident involving Alaska Airlines caused a temporary grounding and inspections of certain Boeing 737 Max-9 aircraft.

Essentially, the FAA order affects roughly 171 planes worldwide, with Alaska Airlines and United Airlines ( UAL ) taking precautionary measures.

As one can imagine, the incident raises questions about the overall safety of the Boeing 737 Max series.

Even worse, the Alaska Air flight involved a brand-new Boeing Max variant, delivered in October. It also has 19 planes on order, according to this source .

Hence, the incident has triggered concerns about the integrity of the plane's design and manufacturing, adding to Boeing's (and Spirit's) existing production challenges and regulatory hurdles.

China, the first to ground the Max after previous crashes and one of the biggest growth markets for commercial aviation, is considering a response to the recent incident, which could have a significant impact on Boeing's orders.

On a side note, I believe that China has been working on a way to somewhat decouple from the Airbus ( EADSY ) and Boeing duopoly for years. It is still far away from building its own planes on a mass scale, but these incidents do not help Boeing's position in China.

Based on this context, the same Bloomberg article mentioned that Boeing has faced numerous production issues, including faulty installations by suppliers and quality-control problems. The main supplier with issues is Spirit AeroSystems.

Just When Things Were Improving

Although it needs to be seen how bad the impact is, we can expect that this incident will derail the recovery SPR has been working on.

After all, this incident will almost certainly come with a wave of additional work to improve and guarantee the safety of the remaining Max-9 models (assuming other Max models do not have these potential issues).

This is what I wrote in my October article:

[...] if SPR can effectively address its operational issues and streamline its supply chains, it may see significant growth, potentially doubling in value over the next four to five years.

In November, the company revealed its most recent quarterly earnings, which included the comments that demand had improved.

During the call, the company acknowledged the evolving landscape of market demand, emphasizing the substantial changes witnessed over the past couple of years.

Despite the challenges posed by a less stable global environment, the company reported unprecedented demand in the aerospace sector. This demand surge is particularly notable in Spirit AeroSystems' core segment, where they currently have a substantial $42 billion backlog.

Even better, the company tightened its relationship with Boeing with a memorandum of agreement ("MOA"), bringing an immediate higher price on the 787 program, resulting in a $350-370 million reversal of forward loss and material right obligations.

The MOA also includes a release of claims and liabilities, funding for tooling and capital, and extended repayment dates on customer financing.

It also benefited from higher deliveries, as revenues in 3Q23 were $1.4 billion, up 13%, driven by higher production on various programs.

• Commercial segment revenue increased by 10% in the quarter, driven by higher production volumes. However, the operating margin decreased to negative 7%, mainly due to higher unfavorable changes in estimates and excess capacity costs.
• Defense and Space segment revenue grew by 27%, reaching $206 million. Operating margin decreased to 5% due to higher changes in estimates. Forward losses of $15 million were driven by the Sikorsky CH-53K program.
• Aftermarket revenues were $97 million, up 21% from Q3 2022, primarily due to higher spare parts sales. Operating margin for the quarter was 19%, down from 24% in the same period of 2022, driven by sales and model mix.

Unfortunately, disruptions like the IAM work stoppage and the 737 aft pressure bulkhead issue affected deliveries, negatively impacting revenue. EPS was negative $1.94, operating margin was negative 9%, and forward losses totaled $101 million.

Bear in mind that Spirit is still dealing with the bulkhead problem , as it improperly drilled holes in 737 fuselages.

As a result, free cash flow usage for the quarter was $136 million, impacted by working capital issues and disruptions.

Full-year free cash flow is expected to be in the range of negative $275 million to negative $325 million.

The company ended the quarter with $374 million of cash and $3.9 million of debt. It is expected to end the 2023 fiscal year with $3.3 billion in net debt, which would translate to a 9.0x net leverage ratio, which is very elevated.

Excluding the potential impact of new challenges, 2024 is expected to see a net debt ratio decline to 4.7x EBITDA, entirely driven by higher EBITDA.

Moreover, addressing $1.2 billion in 2025 debt maturities is a near-term priority, which means there is not a lot of room for error in 2024.

During the Q&A session of its earnings call, the company highlighted significant positive developments in both the 737 and 787 programs. In the case of the 737 program, the company emphasized a strategic focus on achieving positive free cash flow and stabilizing program performance.

A key highlight was the plan to increase production rates, targeting the 50s in 2025, with a strong emphasis on synchronization and stability in internal operations.

According to Spirit, Boeing's confidence in meeting demands in 2024 and navigating the complexities of 737 production, which involves around 25,000 parts per fuselage at a rate of 42 per month, underlines the optimistic outlook for the program.

Depending on the severity of new issues, I believe the 737 program will remain a headwind for a bit longer - just as things are improving...

Valuation

The valuation is extra tricky for two reasons:

• I'm writing this article before the market opens. Currently, the stock is down 18% pre-market, which is reflected in the valuation. Even during market hours, it is likely that volatility will be through the roof.
• It needs to be seen how big the financial impact of the new incident is. This has NOT been reflected in the financial numbers. It could take a few weeks until that is the case.

Based on an 18% lower market cap, the stock is currently trading at 6.8x 2025E EBITDA. A target of 8.0x EBITDA would imply roughly 20% upside from $26 per share (which I am using as a basis here, as it's -18% from the prior close).

This would put the price target at roughly $31. The current consensus price target is $31.70.

On top of ongoing uncertainty, my fear is that these issues will come with additional costs, hurting free cash flow and increasing borrowing costs.

This could make refinancing 2025 debt much more expensive and hurt the longer-term free cash flow outlook.

Hence, I am no longer Bullish on the stock.

In October, SPR was a fantastic recovery play. After its recent rally, that is no longer the case.

As a result, I will continue to focus on other suppliers, like RTX Corp. ( RTX ), General Electric ( GE ), HEICO ( HEI ), and TransDigm ( TDG ).

Needless to say, I'll continue to monitor the situation for new buying opportunities down the road.

Takeaway

The recent incident involving Alaska Airlines' 737 MAX-9 has dealt a significant blow to Spirit AeroSystems and Boeing.

While thankfully no lives were lost, the event has raised concerns about the safety of the Boeing 737 Max series, potentially impacting global orders.

This comes at a challenging time for SPR, which was already grappling with production issues and regulatory hurdles.

The incident is expected to disrupt SPR's recovery efforts, potentially derailing the positive momentum it had gained.

With uncertainties looming over financial impacts and increased costs coupled with a high debt level, the outlook for SPR appears challenging.

As a result, I've shifted from a bullish stance to a cautious one, exploring alternative investment opportunities.

For further details see: