2023-04-24 04:44:57 ET
Summary
- CPI Aerostructures' 2022 results showed significantly lower revenues but an expansion on margins.
- CVU margins underperform the industry.
- After an enterprise valuation, I see little reason to invest in CPI Aerostructures stock.
For me an ideal investment in the aerospace industry is not just an investment in the original equipment manufacturers. There are attractive opportunities in the services and supply chain supporting the aerospace industry as well. A few examples are Park Aerospace ( PKE ) and AerSale ( ASLE ). In this report, I will be discussing CPI Aerostructures ( CVU ) which reported its fourth quarter results recently and provide an analysis of the stock price prospects.
About CPI Aerostructures
CPI Aerostructures has a market cap of less than $50 million so it is a rather small name that not everybody will be familiar with. So, a small introduction might be useful. CPI Aerostructures manufactures structural assemblies for Tier 1 and Tier 2 suppliers as well as a prime contractor to the Department of Defense. The company primarily focuses on Defense but has a very small exposure to commercial aerospace.
CPI Aerostructures is involved in a wide variety of programs. What is somewhat unfortunate is that the last time we were given a timeline for each or many of the programs was two years ago, but we do know that there are some programs that have significant revenue generation potential ahead such as some Lockheed Martin programs, namely the F-16, F-35, CH-35K and UH-60 Black Hawk. With the positive momentum in defense , one could think that CPI Aerostructures has a lot of growth ahead. The reality, however, is that the first big contract flows are expected in 2024 with deliveries in later years. For a company such as CPI Aerostructures that will mostly result in multi-year programs being stretched further and not necessarily in significant rate breaks that provide higher revenues from one day to the other. Apart from that some running programs are offsetting legacy program completion.
With that in mind, it is always good so see contracts such as recently announced for welded assembly valued $3.6 million. Though not big, those contracts do help add value for CPI Aerostructures as well as continuity.
One thing I read about CPI Aerostructures on this platform is that management had to write off on certain programs resulting in tremendous losses and the accounting was labelled as error-prone. CPI Aerostructures had to restate its financial results , but calling the losses tremendous and the accounting method leading to earlier losses error-prone is not reflective of things. The cost-completion method where a portion of the revenue is recognized as costs are incurred is a standard in the defense industry as programs run years and often decades. Occasionally you will see catch up adjustments being made. Specifically to the charge on the A-10 Thunderbolt from 2014, the charge was triggered by an earlier termination of the wing replacement program and that was not because management made a mistake there. The reason was that the Air Force was under budget pressure forcing it to choose for a retirement of the A-10 Thunderbolt and no longer invest in it while prioritizing the F-35 as its replacement. The result was that a lower quantity of wing replacements would be performed than initially anticipated which means lower revenues and higher unit costs indicating lower margins and the revenue recognized on the program to-date is too high and needs to be reverted. On ongoing programs with all defense companies we know this as catch up adjustments which can be either negative and positive and in the case of program termination those adjustments are obviously negative, but having an early program termination is not a common thing. It does happen in the defense industry, but it is certainly not something that occurs every day, not even every year.
Moreover, if you look at the costs of the F-35 for manufacturing and operations the choice for the F-35 rather than rewinging the A-10s made little sense and this was also recognized in Congress and the decision to retire the A-10s was reversed. Data from the evoX Defense Monitor shows that by 2019, the US Air Force awarded Boeing, the prime contractor on the A-10 wing replacement program, an indefinite-delivery, indefinite-quantity contract valued $999 million for up to 112 new A-10 wing assemblies and up to 15 wing kits and Boeing subsequently awarded a $48 million IDIQ contract to CPI valued $48 million offsetting the $47 million charge when the contract vehicle were to be fully utilized. That really goes to show that neither management was at fault nor is the accounting practice error-prone. Claiming either of the two is just a misrepresentation of what actually happened.
The CPI Aerostructures Results in 2022
Year-over-year revenues declined by roughly 20% while net income increased by 35%. However, this was driven by a revaluation of the company's deferred tax assets. If we look at income from operations, we see that there was 53% jump or a margin expansion of nearly 3 percent points and even 5.1 percent point on gross margin level due to positive mix impact and operational improvements. Income before taxes declined from $6.8 million to $2.6 million but that was driven by a $4.8 million loan received as part of the CARES Act.
Outlook For CPI Aerostructures in 2023
For 2023, the company expects slightly higher revenues which doesn't fetch with the $116 million analyst estimate which would indicate a 40% jump in revenues. A recurring element seen in analyst estimates is that at times they do not at all reflect what the business is guiding for, which I think is problematic given the fact that many investors look at these estimates as a starting point when doing due diligence.
CPI Aerostructures: Hard To See Upside For The Stock
Valuation CPI Aerostructures | |||
Market Capitalization [$ million] | $ 44.5 | ||
Total debt [$ million] | $ 29.7 | ||
Cash and equivalents [$ million] | $ 3.8 | ||
Total Enterprise Value [$ million] | $ 70.3 | ||
EBITDA 2023 [$ million] | $ 6.8 | ||
EV/EBITDA | 10.3x | ||
WACC | 9.9% | ||
Current price | $ 3.54 | ||
Median | Current | Industry | |
EV/EBITDA | $ 6.52 | 12.6 | 15.54 |
Price target | $ 2.04 | $ 3.94 | $ 4.87 |
Upside | -42% | 11% | 37% |
I think it is quite difficult to see meaningful upside for the stock. I calculated an enterprise value of $70.3 million and using an EBITDA margin expansion to 8% and revenue growth of 2.5%, we get to an EBITDA of $6.8 million. Using an EV/EBITDA multiple of 6.5x which has been the mean for CPI Aerostructures over the past years, there actually is 42% downside. Applying the current EV/EBITDA multiple gives us 11% upside and applying the industry multiple gives us 37% upside.
Perhaps with higher margins, a better enterprise multiple is justified and so viewing CPI Aerostructure stock as one with over 40% downside might not be fully reflective of the current state of the company, but applying the current enterprise multiple provides barely any upside that I would consider to be worth the investment. The stock price that flows out from the applying the industry multiple looks significantly more attractive but to be fair enterprise multiple expansion is not something that I like to be built on. Furthermore, with a 6.7% EBITDA margin and 8% assumed for 2023 the CPI Aerostructures margin falls short of the mid-teens margin from the industry so I could also see why it doesn't trade more in line with industry.
Conclusion: Don't Buy If You Don't Own CPI Aerostructure Stock
I don't have a lot to say about the financial results. In 2023, we could be seeing some upside to results based on margin expansion and slightly higher revenue but this is not a high growth name. Admittedly, you can apply any EV/EBITDA multiple you want but it has to be based on something. I could see why the median multiple might not be reflective of the forward valuation of the company, but I also could understand why CVU stock does not trade more in line with the industry. So, what is left is 11% upside based on slightly higher revenues and margin expansion. For me, that is definitely not enough to consider a buy rating for the stock.
For further details see:
CPI Aerostructures Stock: Overvalued Or Upside On Multiple Expansion?