PKE - Park Aerospace: Room To Fly Higher

2023-09-26 05:35:34 ET

Summary

• Park Aerospace is a supplier to major aerospace and defense programs, from supporting the engines on Airbus jets to the struts on the James Webb space telescope.
• PKE stock has seen a total return of over 40% and is currently trending up strongly.
• In spite of the flat recent quarterly financial results, the company has enacted very shareholder policies and has tremendous growth opportunities ahead of it.

I have made a handful of investments over the past few years in small-cap stocks that have had surprising ways of turning up in the background of my daily life, mostly from their contributions to some fairly substantial projects. For example, I just recently saw reprinted in the paper an image of an "actively forming star" taken by the advanced James Webb space telescope, and while admiring the image for a moment, my second thought was "I am invested in a company that indirectly helped bring me this amazing image." Park Aerospace (PKE) is a modest American supplier in the aerospace and defense industries that ultimately feeds into the likes of things like jet engines used on single-aisle jets, Patriot missile systems, and even supplied struts for James Webb telescope.

For a brief introduction to anyone unfamiliar with Park Aerospace, the company thrives on its contributions to the LEAP-1A jet engine program administered by the General Electric ( GE ) joint venture known as CFM International, which produces the engines that end up on the Airbus ( EADSF ) ( EADSY ) A320neo and A321 family of aircraft. Its overall revenues are nicely distributed, however, with 52% coming from commercial aircraft programs, 41% from military programs, and the balance from business aircraft [as of Q1 2024]. It has less direct exposure to Boeing ( BA ) at the moment, and no connection to the GTF engine program run by Pratt & Whitney [now under RTX Corp. ( RTX )] that has run into durability issues. Park has the benefit of being aligned with first-class manufacturers in overall quality and safety, and thus far has not had to contend with any indirect reputational damage from its key partners.

I first started picking up shares in Park Aerospace in January of 2020, reinvesting my dividends and adding new money from time to time. In addition, I have written about it multiple times for Seeking Alpha, but have not updated my views since June of 2022, a time when I upgraded my view from a hold to a buy relative to earlier in 2022 due to the announcement of share buyback program. In the intervening months, the stock has brought a total return over 40%, with a large run-up in recent days particularly, essentially matching its 52-week highs set in earlier in March. After setting that peak some 6 months ago, shares have been relatively range-bound between ~$12.50 and $14.50. With the shares now trending up strongly over $15, it is a good time to re-examine the investment thesis.

Review of Most Recent Quarter's Financial Results and Share Price Action

Before getting into the numbers, I think it's helpful to point out that Park Aerospace runs its fiscal year generally from March 1 to February 28, so the most recent available quarterly figures are for Q1 for the company's fiscal year 2024 [from March to May of 2023].

While total revenue ticked up nicely to $15.6 million for the quarter as compared to $12.7 million in the same period a year ago, gross margins were overall similar and the SG&A expenses were a million dollars higher at $2.6 million, so there was no growth in earning per share, coming in at $0.09. Management pointed to the continued impacts of inflation on inputs, from materials to labor to freight, and it all weighed on the final results.

Turning to the balance sheet, cash and marketable securities stood at $81.1 million, dropping some $24.3 million over three months. The drop in cash correlates with generating minimal cash from operations for the quarter, selling or allowing to mature some $26.2 million in marketable securities over the quarter without any offsetting purchases, and distributing $23.0 million in dividends, which was massively elevated relative to other periods due to the distribution of a $1.00 special dividend paid out in the quarter.

There isn't anything specific about the results that really sparked excitement in the market. The earnings call and 10-Q were released in the first week of July, and the shares showed little change at the time, and there hasn't been any material announcement from the company since that time to directly explain the share price. Average daily volume for the past year has been ~58,000 shares, with a high volume of 5.5 million back one day in mid-March, but volume has been well above average as the share price has risen recently, starting on September 12 with 259k, 98k on the 13th, 116k on the 14th, 254k the 15th, and dropping back under the 100k level since then.

With no clear news driving the volume spikes I won't speculate on reasons why, but whatever the reason, clearly more buyers have entered the market than sellers over the last couple of weeks. Nor has there been any particularly bullish information upstream in the aerospace industry into which Park supplies specialized equipment, either specifically pertaining to Airbus jets or in terms of the National Defense Authorization Act . Park does a fairly significant book of its business ultimately with the General Electric jet engines, and the only news of particular note there is that some forged parts may have made their way into an engine that is unrelated to the programs Park Aerospace feeds into. Of course, other nations may be upping their spending on defense programs, whether in response to the efforts in Ukraine, concerns over Taiwan, or other potential hot spots, but there is no way to make a direct link between anything in the news and Park Aerospace's share price action over the last 3 weeks.

Valuation

With the modest run-up in the shares, the value proposition in the equity is less attractive today than it was a month or so ago, but could still be compelling. In the earning presentation , management carefully distinguished that they were not giving any official or formal forecast for the year at that point. However, they did offer a limited picture of their expectations, factoring in only growth from programs for which Park is the sole-source, with the admission that the timing cannot be controlled and may not occur in the current year. Starting from fiscal year 2023 basis and adding assumed growth for just those programs (which include GE engine related sales and some defense programs), revenue could rise to $110.4 million primarily on the back of tremendous growth in the GE engine program and three specific defense programs, with a final potential EBITDA of $34.8 million. The basic steps in their logic are outlined in the following slide from the presentation deck.

In comparison, fiscal 2023 had a total sales of $54.1 million, and EBITDA of $11.5 million, so on the surface, this is clearly an impressive growth outlook, but one seemingly justified by the growing order book for the Airbus models that Park supports. Even if only a modest percentage of these convert to deliveries, it is a long line-up of work for Park just from the Airbus business alone.

Taking the EBITDA figure of $34.8 million relative to enterprise value of $235.6 million, and the forward EV/EBITDA multiple is only 6.77x. The enterprise value used for this initially is based on the value found on the Seeking Alpha valuation page, however the presentation does outline that the cash balance of $81 million could be coming down to $57.5 million due to making certain potential capex investments if the company proceeds with two possible new projects, in addition to tax installment payments. The cash figure does not factor in any assumed share repurchases during Q2 or contribution from internally generated cash. Nevertheless, substituting the $57.5 million figure for cash derives an enterprise value of ~$259.0 million, and puts the EV/EBITDA multiple to 7.44x.

Either way, it remains a relatively inexpensive multiple, but only if the EBITDA materializes as hoped. But even if it falls somewhat short, there is a fairly nice margin for error to still fall within range of fair comps. For example, Leonardo DRS Inc. ( DRS ) sports a 14.68x forward EV/EBITDA multiple, AAR Corp. ( AIR ) is at 10.01x, and VSE Corporation ( VSEC ) is at 11.93x.

By these comparisons, coming in under 10x is a good indicator of a valuation gap that can potentially catch up, and EBITDA could come in around $9 million less than the illustration management provided (~25% short), and still sit around that 10x multiple. If EBITDA meets the $34.8 million benchmark and the market recognizes the value just at 9.00x, shares would be closer to $18. On the other hand, EBITDA could well surprise to the upside, both as pricing improves going forward and/or inflation eventually moderates, and as other initiatives come together, although these likely would only being to contribute to EBITDA on a longer-term basis.

Concluding Thoughts

Park has taken multiple steps to address shareholder frustrations regarding its fairly large cash balance that stretched back for the past few years, even after completing a large investment to expand its production capacity in Kansas. The decisions have included raising its normal dividend from $0.40 per year to $0.50, making a one-time special dividend of $1.00, and also starting to repurchase shares. While the special dividend has now come and gone, the ongoing benefit of the higher normal dividend (yielding over 3%) and share buybacks are net positives that still carry forward, and are in stride with additional growth opportunities that are abundant. The cash on hand has come down from well over $100 million to something closer to $55 to $60 million, but Park remains well positioned to put more of that cash to use for value creation.

The valuation has not become stretched even after the recent gains, and for long-term investors, I believe Park Aerospace remains a "buy," with the sole caveat that I do not expect a 40% total return to repeat itself. My price target is $18, reflecting a 9.00x EV/EBITDA multiple, roughly a 14% gain not including dividends (and not factoring in buybacks).

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