Given its close ties with Boeing (NYSE: BA) and the plane maker's troubled 737 MAX program, it's surprising that shares of Spirit AeroSystems (NYSE: SPR) are only down 9% since the tragic March 10 Ethiopian Airlines crash that took 157 lives and led to the entire MAX fleet being grounded.
Spirit, a one-time wholly owned subsidiary of Boeing, is still highly dependent on the company. Spirit is responsible for about 70% of the 737's structure, as well as a range of engine components and wing parts, and the 737 accounts for about half of Spirit's annual sales.
Here's a look at how Spirit AeroSystems is coping with the crisis and trying to make sure it is better prepared in the event something similar ever happens again.
Making the best of a bad situation
Boeing, in response to the grounding of the 737 MAX, temporarily reduced its production rate on the aircraft to 42 frames per month, down from 52, but the company has taken steps to cushion the blow on suppliers. Boeing and Spirit in April signed an agreement that allowed Spirit to keep current production levels in place, with all airframes above Boeing's production rate being paid for upon completion but stored at Spirit facilities.
Spirit AeroSystems is responsible for the fuselage and about 70% of the structure of a Boeing 737. Image source: Spirit AeroSystems.
Spirit is also receiving some advanced payments from Boeing for material purchases. But the supplier does have to cover the costs associated with storing the extra production.
Company CEO Tom Gentile on a post-earnings call highlighted the steps Spirit is taking to help it wait out Boeing's issues. The company has reduced overtime and use of contractors, implemented a hiring freeze, and cut discretionary spending. Spirit has also delayed capital spending by about $50 million, pushed forward working capital reduction initiatives, and has paused its share repurchase efforts to conserve cash.
Gentile said Spirit is also carefully watching its supply chain for signs of stress and dealing with issues on a case-by-case basis:
Our goal is to make sure we monitor the financial health of all of our suppliers, and we're paying particular attention to suppliers who may have weaker financial positions. But we've come up with a variety of solutions. We're not changing their schedules right away. So in some cases we're tapering them down so that we can absorb the inventory. In some cases we're converting what might be vendor-owned inventory and the Spirit-owned inventory; that was the purpose of the advance from Boeing. The goal is to make sure the supply chain remains healthy throughout this process.
Despite the issues, Spirit was still able to put together a solid quarter. It reported adjusted first-quarter earnings of $1.68 per share on revenue of $2 billion, beating the consensus estimate of $1.65 per share in earnings on revenue of $1.94 billion. Adjusted free cash flow improved 77% year over year to $209 million, reflecting higher cash receipts from customers, lower incentive compensation payments, and its ongoing streamlining work.
Spirit ended the quarter with a backlog of $48 billion. Operating margins improved at each of the company's three segments, thanks to higher production volumes and a better mix of newer, more lucrative programs.
Source: Spirit AeroSystems first quarter earnings report
Spirit has spent the last few years streamlining operations and divesting unprofitable and low-margin businesses, helping to improve overall profitability.
But the full impact of the 737 MAX is still to be determined. Spirit has suspended its guidance for the full year, in part because it had baked in a planned June increase in 737 frame deliveries to 57 from 52 that now seems highly unlikely. The company has won some assistance from Boeing to help it weather the crisis, but uncertainty will linger around Spirit until the MAX is airborne again.
Looking beyond Boeing
Perhaps it is no surprise given Boeing's ongoing issues that Spirit AeroSystems was quick to point out on its call all the business it has in development not tied to its former parent.
The company in the quarter began low-rate deliveries of complete fuselage and cockpits of the CH-53K King Stallion heavy-lift helicopter to Lockheed Martin's Sikorsky unit. It also reached a collaboration agreement with start-up Aerion to design a pressurized fuselage for that company's planned supersonic business jet.
But the real answer in terms of diversification is M&A, and Spirit last year took a big step toward broadening its base when it agreed to buy Asco Industries for $650 million. Asco is a $400 million-in-sales private company that supplies wing structures, assemblies, and other components used on a range of platforms, generating about half its sales from Airbus and an additional 30% from other non-Boeing customers.
Spirit AeroSystems is pivoting beyond from the 737 MAX. Image source: Boeing.
Spirit had hoped to close that deal by now, but issues with European regulators led to delays, and the companies now intend to complete the acquisition during the current quarter. Gentile on the call said that "we want to remain disciplined" when it comes to dealmaking but signaled the company could seek other transactions to lessen its reliance on its Boeing commercial heritage.
"As we go forward, our inorganic strategy will continue to remain on things like more Airbus content, more military content, more low-cost country footprint, more fabrication capabilities," Gentile said.
An enticing new opportunity just hit the market when Bombardier (NASDAQOTH: BDRBF) said it would sell a facility in Northern Ireland as part of its continued cost-cutting efforts. The plant makes wings for the Airbus A220, formerly known as the Bombardier C Series -- and Spirit, which is already a supplier to the A220, appears the most logical U.S. buyer.
A gold star for effort, but not a buy
As said above, given the issues surrounding Spirit AeroSystems' most important program, the company has held up remarkably well. Gentile and his team deserve a lot of credit for managing through the crisis while continuing their push to broaden the business and increase their exposure to new customers.
That said, Boeing, Spirit, and the 737 MAX are not out of danger yet, and the current strategy assumes a return to normal in the second half of the year. There is a lot of uncertainty about the quarters to come, and given the relatively benign reaction to the crisis by Spirit shares, this does not feel like a buying opportunity.
Spirit AeroSystems under its current management has the potential to grow into an aerospace overachiever. But given the large number of issues it is juggling, some of which are beyond the company's control, I see no reason to rush in to buy right now.
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