Aerospace structures manufacturer Spirit AeroSystems Holdings (NYSE: SPR) has worked out a long-term agreement with Boeing (NYSE: BA), establishing pricing and capital investment terms with its most important customer and resolving claims related to manufacturing delays.
The deal provides Spirit with much-needed certainty as it looks to invest in its operations, and removes a potential investor worry about the company after a difficult 2018.
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Spirit, a onetime wholly owned subsidiary of Boeing, makes about 70% of the fuselage for Boeing's hot-selling 737 aircraft as well as key components of the 767, 777, and 787 Dreamliner. The long-term agreement sets pricing terms for all models "well into the next decade," including 737 pricing based on production rates above and below current levels.
It also outlines investments for tooling and capital for certain 737 rate increases and calls for the companies to work together to reduce costs for the 777X and 787 Dreamliner. Spirit CEO Tom Gentile in a statement said that with this new agreement, "we expect price to exceed cost eventually on the 787 program."
Post-deal Gentile said Spirit is targeting 7% to 9% conversion of revenue to free cash flow.
Boeing had unfinished 737s piling up at its Renton, Washington, assembly plant last summer in part because of engine manufacturing delays but also due to Spirit's issues delivering fuselages on time and in the right order. Spirit in November said that those delays were largely in the past, but claims surrounding them had remained unresolved until now.
Locking in business
Some elements of the agreement involve reshuffling the timing of payments, and the deal does require Spirit to resume repayments of 787 advances in 2021. Spirit also is locked into an unfavorable pricing structure on the 787 through the next few years.
But the company does gain clarity on pricing for some of its most important contracts through 2030, and removes potential uncertainty surrounding Boeing's ever-changing 737 production plan. And prior to this agreement it was unclear whether Boeing, which has been aggressively expanding into areas historically dominated by suppliers, was interested in continuing to grow its relationship with Spirit.
Boeing is also nearing a decision on launching a new midsize airplane, and Spirit plans to bid for the fuselage work. Given the close relationship between the two companies, Spirit appears the favorite to win that new business, which would create a steady flow of income over the long term but could eat into margins in the years to come due to start-up expenses.
Acquisition still in the works
Perhaps just as important is that Boeing will consent to Spirit's planned $650 million acquisition of Asco Industries. Spirit announced the deal last May and initially hoped to close the purchase by year's end, but the company in October temporarily withdrew the proposal from consideration by European regulators after hitting a snag.
The Asco deal is key to Spirit's long-term strategy to reduce its reliance on Boeing, which still accounts for nearly three-quarters of Spirit revenue 13 years after Spirit gained its independence. Asco supplies wing structures, mechanical assemblies, and other components to a range of Airbus and Boeing platforms, as well as the F-35 fighter and other military aircraft. It generates about $400 million in sales annually.
At the time the Asco deal was announced, Gentile said the target generates about half of its revenue from Airbus and an additional 30% from other non-Boeing customers, and that the purchase would provide better balance to Spirit. It should also help growth rates, as Spirit execs expect Asco to grow by 10% to 12% annually over the next few years.
While Boeing wasn't the reason for the European antitrust delay, the backing of a major customer should help ease the approval process. Spirit hopes to close the deal by the end of the current quarter.
One less worry
Spirit AeroSystems today trades at about 9.4 times forward earnings, well below industry leader TransDigm Group (19.7x) and aerospace-heavy United Technologies (13x). The discount is in part due to its lackluster delivery performance in 2018, but with each passing month it appears those issues are also behind it.
There are still risks involved, including a planned CFO transition, the challenge of integrating Asco, and the chance that as Boeing increases 737 production, Spirit might trip up again. But one huge overhang to the stock, concern about Spirit's long-term relationship with Boeing, has now been addressed with this new agreement.
With Boeing on board, Spirit's success increasingly comes down to how it executes over the quarters to come, and I've liked what I have seen so far from Gentile and his team. Right now I still prefer TransDigm, which despite its higher valuation has a concentration of proprietary products that are hard to commoditize, or even Boeing itself, but I'll be watching Spirit closely in the months to come.
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