Astronics (ATRO) is an undercovered play in aerospace and test systems. For years, Astronics was regarded as a great growth company, supported by dealmaking, as it has seen a few rough years in which sales were consolidating despite growth in end markets.
In this previous article, I liked the period of consolidation which resulted in a reduction in expectations and valuations, while leverage multiples were coming down following multiple acquisitions in the years before. Furthermore, the results of Astronics were hurt by the smaller test segment which has seen real pressure on its sales, thereby "hiding" the resilient performance of the core business.
Dealmaking, Consolidation, Growth?
Astronics was just a $150 million business in 2007 as it steadily grew sales to roughly twice that number by 2013, before it announced the acquisition of Pepco for $136 million that year alongside other bolt-on deals. Sales hit a peak of nearly $700 million in 2015 as much of the growth was financed by debt and the issuance of shares, as the share count was up two-thirds since 2007. Nonetheless shares rallied from high single digits during the crisis to a peak of $75 in 2015 as investors liked "roll-up" plays during those days.
After sales peaked in 2015, they have been falling quite a bit to $633 million in 2016, before seeing mild pressure again in 2017. Two years of sales declines made that shares hit a low of $25 in the summer of this year.
When the company posted 2016 results in February of last year, Astronics guided for sales to come in between $640 million and $720 million in 2017 as shares were still trading in the mid-30s at the time on the back of the projected sales growth.
First-quarter results were reported in May and revealed an unexpected decline in sales as the company cut the sales guidance to $635-690 million. The sales decline only worsened during the second quarter as the company cut the guidance further to $625-645 million, causing shares to hit a low of $25.
In October, Astronics announced the acquisition of Telefonix in a $104 million deal. The Illinois-based company provides in-flight entertainment and connectivity solutions and is expected to generate $60-70 million in sales in 2017 with EBITDA margins being similar to the aerospace business of Astronics.
The third-quarter results in November revealed that sales declines were flattening out. This positive sign in combination with M&A interest in the sector made that shares had already recovered to the mid-30s. The company further narrowed the full-year sales guidance to $622-636 million. The company ended the third quarter with $16 million in cash and operates with $177 million in debt. This net debt load of $161 million will jump to $265 million following the closure of the Telefonix deal.
Astronics just came out with some great news as it reported orders of $229 million in Q4. The Aerospace system segment reported very strong orders of $171 million, which include a $17 million contribution from the acquired business of Telefonix. The real kicker came from the test segment with $58 million in orders while this is just a +$100 million business per annum!
On the back of these strong results, the company sees 2018 sales between $745 million and $815 million, as the guidance range is quite wide (as is always the case), as I remember that the company started 2017 on an upbeat tone as well. The midpoint of the sales guidance at $780 million implies that the "core" of Astronics will be on track to have a record year as well with Telefonix sales running at $60-70 million a year.
Astronics has been able to post operating margins of around 15% in recent years although margins have been trending towards the 10% mark amidst sales stagnation and increased investments into development. Assuming that margins jump back to 14% again following the sales leverage, I see EBIT this year at $109 million. Adding back annualized D&A charges of $25 million to this number, and adding back another $3-4 million in D&A for Telefonix, I see EBITDA at $135-140 million a year. With net debt following the latest deal standing at $265 million, leverage remains reasonable at just below 2 times.
Operating earnings of $109 million and a 4% cost of debt leave earnings before taxes of $98 million. After a 20% tax rate that leaves earnings of $78 million, or potential earnings of close to $2.70 per share. Hence the 15% move higher in the shares does not make them look too expensive. After all shares are trading at 17 times forward earnings while the business has real momentum, and leverage will quickly fall below the 2 times mark, making shares not too expensive. Furthermore, M&A interest in the sector is elevated as most peers trade at multiples in excess of 20 times.
I have started to buy into Astronics' downturn when it first hit the 30s and added in the 20s last year. While I have been tempted to sell out some shares following the rally in recent months, I am glad that I was surprised by this positive outlook for 2018.
The good news is that even after a 15% move higher, shares do not look too expensive. A business with a great growth profile and modest leverage should be able to fetch 20 times multiple, leaving fair value at $55 in my opinion and potentially move if and once the market believes Astronics should trade at a modest premium on the back of its dealmaking capabilities and willingness to make deals.
As a result, I continue to hold onto my shares as I believe that Astronics could still fly higher in 2018 even after this already great start to the year.
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Disclosure: I am/we are long ATRO. 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.