Odds of faster recovery lifted aerospace and defense “A&D” stocks after the FDA authorized a Coronavirus treatment on Monday. Still, debates around the treatment’s effectiveness show that returning to normal is bound to the development of a vaccine.
Low price multiples are luring value-investors who cite solid defense budget and higher air freight demand as reasons to expect a reversal in A&D stocks. Short-term traders are also drawn to the industry as technical analysis tools beep oversold beacons.
While you can find A Ruby Beneath The Rubble, low demand for air travel combined with high fixed costs resulted in large cash burns, pushing many A&D balance sheets deeper into the red, making it almost impossible for some companies to create value for shareholders in the coming years. One such company is Triumph Group Inc (TGI).
TGI is a manufacturer of a wide range of jet components. Its products end in commercial and military airplanes made by Boeing (BOE), Northrop Grumman (NOC), and Lockheed Martin (LMT) among others. The company’s line of business and the association with big A&D names convey an exciting picture of rockets, stealth tech, and supersonic aircraft projects using cutting-edge innovations that transform the world. The reality is different.
Cost-cutting initiatives cut company expenses to the bone leading to a deterioration of employee morale. The company has stopped investing in R&D since March 2017. For years, the company’s capital expenditure wasn’t enough to replace its aging facilities, equipment, and assets after the company cut its capital expenditures by 60%.
TGI’s big product catalog grew because of years of M&A deals that transformed the company into an intricate web of businesses overlapping in scope and operations. Duplicative back-office processes and the overlapping operations increased costs and caused production delays. Gulf Stream put TGI in the no-bid list before the management restored the relationship.
Turn Around Plan
TGI’s much-anticipated 2016 turnaround plan which aimed at increasing organic sales, profit margins, and lowering debt showed mediocre results at best. Now, success is even less likely.
Recently, as part of its restructuring efforts, TGI sold 2 non-core businesses for about $100 million, but this is too little too late. The company will struggle to sell more assets at satisfactory prices during this downcycle.
With +$2 billion long term debt, TGI is one of the most indebted companies in the A&D industry. Its debt to asset ratio is three times that of Lockheed Martin and more than double that of Boeing.
TGI’s new $700 million 8.875% debt issuance earlier this month will raise annual interest payments from ~$122 to ~$155 million based on my estimates.
JP Morgan cut TGI’s rating to underweight citing mounting debt and aviation woes. Moody’s and Standard and Poor’s rating services assigned a B2 and B- rating for the latest debt issue respectively.
Historically, new jet productions drove ~90% of TGI’s revenue while ~10% were related to maintenance, repair, and overhaul services “MRO” (for both commercial and military). In the coming quarters, MRO business will have a higher portion of TGI sales as airlines scale down route expansion.
Revenues from the military will rise due to higher defense budget for FY 2021. All in all, the company estimates $1.85 billion in revenue this fiscal year, a 35% YoY decline.
Can TGI Service Its Debt?
TGI has volatile profit margins due to restructuring and impairment costs related to its turnaround efforts. In the past 5 years, the annual EBITDA margin ranged from -22% to 8.21%.
Adding costs related to restructuring gives a picture of the company’s profitability in the future, in a normal course of business. Below is a table showing adjustment to EBITDA
Source: Company filings. Figures in 000’s
Using a 9% EBITDA margin, TGI will hardly pay interest expense, preventing it from creating value for investors. The problems of TGI are deeper since this analysis does not account for depreciation, amortization, restructuring, loss from the sale of assets, and impairment of intangibles.
Low demand for air travel combined with high fixed costs resulted in large cash burns, pushing TGI’s balance sheet deeper into the red. As a result, TGI will struggle to create value for shareholders in the coming years.
Management turnaround initiatives are cutting expenses to the bone damaging competitiveness and employee morale. It is less likely that the company will succeed in implementing its turnaround plan during the current downward cycle.
If you like this article, please click the follow button.
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.