RDW - Redwire: Q1 Earnings Were A Pleasant Surprise

2023-05-25 14:51:05 ET

Summary

• I was previously bearish on space roll-up Redwire.
• Shares have fallen significantly since my last report, meanwhile the business is showing signs of operational momentum.
• The balance sheet has issues which is a risk that keeps me from being bullish. But I'm upgrading to a hold rating.

Redwire ( RDW ) is a small company focused on the space industry. It came about as a roll-up of more than half a dozen firms that offer specific products and services for the space sector. Redwire came public via a SPAC. It appears shares were significantly overvalued at their original offering price when compared to the sum of the parts in terms of the acquisitions that made up Redwire.

I covered Redwire in February after shares spiked 50% for little apparent reason, warning that investors should sell the pop . RDW stock has settled back down since then, with shares moving toward the bottom end of their trading range:

So, with shares down 35% since my last article, it's worth updating on the situation. And, of interest, while the stock price has fallen, the company's last earnings report actually had some significant positive developments. As such, the outlook for Redwire has improved.

Q1 Earnings: Not Too Bad

Redwire's Q1 earnings per share came in at a loss of 18 cents. This was below the analyst expectations of a 10 cent per share loss, which might suggest that the quarter was a disappointment.

However, I'd argue that analyst expectations were perhaps unreasonable. Because, looking at revenues, Redwire reported $58 million for the quarter, which soared past the analyst consensus of $48 million. The huge revenue beat combined with earnings miss suggests that analysts may have modeled the company's gross profit incorrectly.

That said, while margins may not have improved as much as hoped, they are improving. Gross margin jumped from 16% in Q1 2022 to 25% this past quarter. That's still a low gross margin in the grand scheme of things, and Redwire needs to make further improvements. But it's a significant move in the correct direction and gives some hope that there is a good business model here once the industry grows in size and Redwire can scale up operations.

The thing I'd really give Redwire credit for is that it is keeping a firm handle on expenses. Its revenues soared 75% year-over-year. Excluding acquisitions, revenue grew 38%, showing that there is solid organic activity in the company's backlog as well. And even in the face of this rapid expansion, Redwire managed to cut sales, general, and administrative expenses from $21 million in Q1 2022 to $16 million in this most recent quarter.

Adding up the rising revenues, improving margin, and disciplined cost control, and it makes for a favorable trajectory in terms of operating income. Redwire swung to profitability on an adjusted EBITDA basis this quarter. And in terms of operating income, Redwire only lost $2.2 million versus a $17.5 million loss in the same quarter of 2022.

Balance Sheet Is An Issue

Given the favorable items in the earnings report and the significantly improved valuation for Redwire, why am I not bullish on RDW stock today? The main issue is the balance sheet.

Redwire's cash position fell to $11.3 million as of March 31, down sharply from $28.3 million at the end of 2022. As the company is making investments, it is consuming a significant amount of capital at the moment.

Meanwhile, the firm is dealing with $84 million in current liabilities and another $75 million of long-term debt. It seems unlikely that Redwire will be able to navigate the future without raising at least a little more capital.

Yes, the company is rapidly shrinking its losses and improving its profit margins. However, it doesn't seem like it will reach a sufficient level of profitability to internally self-fund its growth efforts in the near-term. And with the cash balance quickly running down, a capital raise could be coming. I would expect there to be an overhang on Redwire shares until we see more clarity in terms of how the company will finance itself over the next couple of years.

Redwire Stock Bottom Line

The thesis around Redwire was that it could roll up a bunch of tiny space companies and turn the whole organization into more than the sum of the parts. I was previously skeptical of this, given the wide gap between the price Redwire paid for its M&A deals and the market capitalization of RDW stock once the SPAC deal completed.

However, it appears that some of these promised merger and platform synergies are actually starting to kick in. Here's CEO Peter Cannito on the Q1 conference call describing the firm's outlook:

"We're significantly improving our gross margin over time, and some of the reason for this is if you think about the history of Redwire, one of the built-in systemic efficiencies that we're able to achieve is to take a lot of the companies that were previously small businesses and inject more programmatic discipline, better systems through things like ERP implementations and taking a hard look at the gross margins and the pricing power that we can achieve by going to market in integrated bundles and things like that as a much larger company."

I'd argue that these Q1 results were a real meaningful sign that this business model can actually deliver on this promise. There's a lot more that needs to be done, and the balance sheet is a major concern. But things are trending in the right direction.

I concluded my article from February on Redwire by saying:

In the bigger picture, the former $2.50 share price seemed to reflect Redwire's risks and possibilities well. There is a real business here with significant commercial demand and revenues in place. However, it is low margin and not growing especially quickly. We also need more evidence to confirm that this heavily M&A driven business model is producing any real synergies or scale.

At $2.50/share, Redwire would be trading at a sub-$200 million market cap, which isn't too rich for approximately $175 million of revenues in 2023. Up at $4, though, it's much harder to get excited. I'd personally be a seller on this abrupt rally and wait for things to settle back down before considering a position in Redwire.

Fast forward to today, and shares are right back at $2.50 each. Meanwhile, revenue growth has been faster than previously modeled. Full-year 2023 revenues are likely to come in closer to $225 million instead of the $175 million that was my prior expectation. Last quarter's results, while still being an EPS loss, were a concrete step in the right direction.

The combination of a much more reasonable valuation and some organic momentum in the business has me feeling significantly more upbeat about Redwire's prospects. As such, I'm moving away from my previous sell rating and going to a hold. Redwire is still a speculative situation, and cash will remain a concern for the foreseeable future. But for space investors looking at small-cap names in the industry, Redwire is worth watching at this price.

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