Astronics - Strength Of The Core Reveals Further Upside

| About: Astronics Corporation (ATRO)

Summary

Astronics posts disappointing results if you look at the headline numbers.

A review of the results shows that strength in the core is offset by lumpy and poor test results.

Solid core organic growth, rapid deleveraging and non-demanding multiples reveal further upside from today's levels.

Astronics (ATRO) is a small aerospace conglomerate which has grown rapidly in recent years. This rapid growth propelled a huge boom in the share price, as sluggish operating performance and worries about leverage resulted in a big pullback from all-time highs.

The company is quite interesting in my eyes as the valuation has become more compelling while leverage ratios have come down. This is even more the case as the core of Astronics is performing very well, with the smaller testing segment "hiding" this strong performance. A break-up of the business or stabilization of the testing segment could highlight the inherent value in the business, creating compelling upside from today's levels.

The Business Overview

Astronics has grown to a revenue base of $700 million in recent years. 85% of these sales are generated from the aerospace segment, in which the company is active with regards to electrical power & motion, lighting & safety, avionics, certification and structures. The remaining 15% of sales is generated by testing solutions, used again in the aerospace business as well as the semiconductor industry.

Typical products installed by Astronics include power outlets, seat automation, lightings, ventilation systems, oxygen masks, antenna systems and in-flight entertainment. These products are installed in numerous types of planes.

The company is still very much a commercial aerospace play, with commercial transportation being responsible for two-thirds of revenues in terms of actual end markets. To continue to provide sophisticated offerings, Astronics is investing heavily into R&D. These investments run at $90 million a year, equivalent to roughly 13% of sales.

Rapid Growth, In The Past

A decade ago, Astronics generated merely $100 million in sales. Organic growth and bolt-on deal-making increased the revenue base to roughly $250 million by 2012 before a real acquisition spree started. Ever since, the company has nearly tripled its revenues.

The company laid out roughly $300 million in the period 2013-2015 in order to buy five companies. The $136 million purchase of Pepco in 2013, an aerospace lighting & structure business, has been the largest deal. Other noticeable deals were the 2014 purchase of the test business of EADS for $69 million and the 2015 purchase of Armstrong for $52 million.

The company indicates that it tolerates a 2-3 times leverage ratio as deal-making appears to be a key priority of the business. It is unfortunate to see growth having stalled in recent times amidst disappointing results for the smaller test segment.

The Current Performance

Astronics just released somewhat disappointing second-quarter results with revenues being down 5% to $164 million. Deleveraging hurt operating margins by 250 basis points to 13.8% of sales, with net earnings being down 15% to $15 million.

The aerospace business performed very well as revenues were up by nearly 8% to more than $142 million. Margins rose by more than 2 percentage points to 17.4% of sales as the order intake of $163 million was particularly strong as well.

The test system business performed particularly poor as is no surprise, with Astronics being reliant on a key customer which sees lower activity levels this year. Revenues were cut nearly in half to just $22 million for the quarter. Operating profits came in at merely a million. While bookings increased by nearly 50% compared to the year before, actual booking numbers of $18 million suggest that the backlog continues to shrink.

Despite the current trends, management remains upbeat on the prospects for next year for this business.

As a result of the disappointing test results, full-year sales are now seen at $655-685 million. Based on this revenue guidance and the results for the first half of the year, operating earnings could come in at $90 million. With interest expenses running at $4 million and a 30% tax rate, earnings could come in at $60 million. With little over 26 million shares outstanding, this is equivalent to $2.30 per share. Given the current share price at $39, the multiple comes in around 17 times despite the underperforming test segment.

A continuation of retained earnings and profits has reduced the net debt load to $146 million, following the $300 million buying spree in recent years. With EBITDA coming in around $115 million, leverage is very contained at 1.2 times.

What Is Next, Looking At The Potential

Shares of Astronics traded at merely $10 during the crisis as acquisition-driven growth resulted in shares peaking in their $70s in the early part of 2015. The slower growth and even worries about leverage triggered a huge sell-off, with shares falling to just $25 at the start of this year. Ever since shares have recovered to current levels around $40.

The real value is seen in the aerospace business, which has the potential to post operating profits of $100 million on sales of $600 million. An unleveraged business could post after-tax profits of $60-70 million and given the growth and positioning might be worth quite a bit. A 20 times multiple for an unleveraged business seems conservative, for a $1.2-1.4 billion valuation.

Note that Rockwell Collins (COL) is a much larger competitor which does operate in similar markets. It is valued at $13 billion including net debt which represents a 13 times operating profits multiple. With sales coming in at $5.3 billion, it trades at 2.5 times sales. If we apply similar multiples to the aerospace business we end up with a $1.3-1.5 billion valuation.

For simplicity reasons, I assume that the testing segment represents sufficient value to cover the current net debt load of the overall business.

A $1.3-1.5 billion equity valuation translates into $50-57 per share, still leaving upside to today's valuation. This is even the case after shares have risen some 40% from the lows in February. To maintain some margin of safety, I would be a buyer in the mid-thirties if shares would potentially show a retreat.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.