WAIR - Wesco Aircraft

[AzCactus]

Hi all,

 

I have been casually watching Wesco as it is the largest holding for Makaira Partners at about 17.5% as of 9/30.  It's fallen pretty hard today to around $14.50 and is currently at a 52 week low.  I listened to the call yesterday and have read through some of the information and long term I think this company will be fine.  To me $14.50 seems like a good long term entry point.  I was wondering if anyone else had done research on the company or had anything to add.

 

David

[Libs]

A quick look, looks interesting so far...

Pretty impressive growth, 15.6% CAGR for 20 years. Up until the 1/14 HAAS acquisition they had mostly grown organically, at least since 2007.

 

HAAS was a big bite though, $550MM, and it looks like they are having integration problems.

 

Down to 10X earnings now, that's interesting.

 

This is how they describe their competitive advantage, from the 10-K. I know nothing about this type of business, I wonder if this rings true for someone who does:

 

 

  We consider our procurement expertise to be one of our principal competitive advantages. Our management is highly skilled in analyzing supply, demand, cost and pricing factors to make optimal inventory investment decisions and we maintain close relationships with the leading suppliers in the industry. In particular, Precision Castparts and Alcoa Fastening Systems supplied approximately 20% and 19%, respectively, of the products we purchased during fiscal 2013. Our strong understanding of the global aerospace industry is derived from our long-term relationships with major OEMs, subcontractors and suppliers. In addition, our direct insight into our customers' production rates often allows us to detect industry trends. Furthermore, our ability to forecast demand and place purchase orders with our suppliers well in advance of our customer requirements provides us with a distinct advantage in an industry where inventory availability is critical for customers that need specific parts within a stipulated timeframe to meet their own production and delivery commitments.

        We have created a structured procurement process that focuses on return on invested capital, or ROIC, and minimizes excess inventory, which helps us maintain what we believe are our industry-leading operating margins and parts availability. Prior to placing a purchase order, members of our supply chain organization analyze a "buy requisition," which is generated by our IT system. Buy requisitions provide several key pieces of information, including the amount of that SKU currently on-hand, a listing of all active customers that use the specific SKU, the quantities and rates at which the part has been consumed by these customers in the past, tiered pricing for various quantities at which the supplier offers price breaks and recent selling prices of various order sizes. Using the information obtained from the buy requisition, a Wesco employee then conducts an ROIC analysis to determine the expected payback period and margin on the specified inventory investment before making the final procurement decision. This calculated approach to inventory investment, combined with our unique market insight, has enabled us to generate and sustain industry-leading operating margins.

 

 

[cpan]

I was looking at this one as well for the same reason (cheers to the other copycats).  Almost got in at a very bad time :-).

 

The valuation just doesn't make sense to me.  They have 1.1b of debt with market cap of 1.4b for a EV of around 2.4b.  The expected free cashflow according to the mgmt on the last conf call was ~45 million.  So eventhough from a PE point of view it looks cheap, its very expensive from a free cashflow to EV.  So now it looks like the margin is shrinking and HAAS is a much more expensive acquasition in hindsight.  From one of the transcript from their competitor B/E aerospace, they said that price of acquisition is very high and thats why BE is not doing any deals.  This looks to be the right call (lets ignore that BE then went and bought some oil/gas distributors). 

 

So I just don't see why these smart guys are owning it.    Maybe someone else can shed some light. 

 

 

[no_free_lunch]

I know nothing about the company but does it make sense to compare EV to free cash flow?  Isn't free cash flow after interest expenses?  The whole point of EV is it's what it would cost to get a debt-less version of the company.  If it was debt-less then you wouldn't have the interest expenses.

[cpan]

 

You are right, I always forget that.  I think the debt payment was ~45million,  So the its  more like ~90million of cashflow vs. 2.4b of EV.  Still very expensive to me or I could have missed something yet again.

[no_free_lunch]

You are right, still not cheap but a little more reasonable.  I think there was a special event in the most recent year, as prior years FCF were fairly close to earnings.  It's an interesting stock, I will dig into it when I have some time.

 

Edit: Their corporate presentation lists 2013 FCF at $85M.

 

Edit2:

 

Wesco Aircraft currently expects fiscal 2015 full-year sales to be between $1.625 billion and $1.675 billion, representing growth of approximately 20 percent to 24 percent over fiscal 2014. Diluted earnings per share are expected in the range of $1.14 to $1.24. Adjusted diluted earnings per share are expected in the range of $1.30 to $1.40, an increase of five percent to 13 percent compared to fiscal 2014. The company also expects free cash flow of $100 million to $120 million in fiscal 2015.

 

http://phx.corporate-ir.net/phoenix.zhtml?c=245867&p=irol-newsArticle&ID=1991827

[BRK7]

On yesterday's conference call, WAIR forecasted F'15 free cash flow of $100-$120.  This is above-trend (as I recall, because of the reversal of some working capital items), but management anticipates that longer-term FCF conversion from net income will be in the range of 60%-65%, which is still about ~$72 million based on forecasted FY'15 net income.  Also, the debt, net of cash, is now just under 1 billion. 

 

Part of the investment thesis, based on reading Weitz’ March 31 Annual report, is that “the company should benefit from the multi-year commercial aerospace build-out that is underway.  We expect this tailwind to provide visible growth until at least 2017.”

 

EV/EBITDA is roundly 10x, using analyst-forecasted F’15 EBITDA and current market price of $14.52.  P/E (using midpoint of management’s F’15 guidance range) is roundly 10.8x.  These figures strike me as fairly cheap, given the historical revenue growth trajectory and the supposed coming industry tailwind (for example, look up the commercial airplane order backlog figures for Boeing).  However, if something has changed about the business, such that margins (on the legacy WAIR business, not the lower-margin Haas business) are permanently impaired, then WAIR may not be as cheap as I think.

 

[BRK7]

From one of the transcript from their competitor B/E aerospace, they said that price of acquisition is very high and thats why BE is not doing any deals.  This looks to be the right call (lets ignore that BE then went and bought some oil/gas distributors). 

 

 

I don't recall B/E commenting about Haas.  Are you referring to B/E comments about acquisitions in general?

[cpan]

Yes, about the acquisition opportunity in the class C parts and supply chain in general.  Not specific to HAAS.  I recall that the discussion was that the price in aerospace industry was was 10-12 times ebita where as the oil/gas exploration distributor was 6/7 times. 

[gym97]

B/E, wairs primary competitor, does not supply to Boeing or its Tier 1/2 manufacturers. WAIR has a disproportionate exposure to Boeing planes and I would have to guess that the majority of WAIRS revenue is indirectly tied to Boeing via its Tier 1/2 suppliers. Boeing has an extremely long runway for its dreamliner and is now manufacturing them like clockwork. There is no more need for Boeing to rely on expensive distributors versus going direct. Boeing is trying to disintermediate WAIR with its own newbreed initatives whereby it centrally buys all fasteners for all of its tier 1/2 suppliers. WAIR and other distributors historically took advantage of fastener shortgages and jacked up pricing (lots of articles on this). They were very adversarial and the relationship between wair and boeing don't sound good (hence their decreasing % as a direct buyer). Now that Boeing has a long, steady, predictable backlog, what is the point of allowing wair to earn those margins given it no longer has unpredictable working capital needs. PCP already supplies 50% of its fasteners to Boeing direct and is interested in doing more.

[no_free_lunch]

Thank for the insight gym.

 

I saw a note on the issue with boeing in their prospectus from 2011.  Given that it's been 3 years is it possible that this has already happened to some extent?

[gym97]

i think it is in the process of happening. i am not too familiar with how boeings dreamliner production works but as i understand it, the last they are only recently getting it together which is a negative for wair in my opinion.

[no_free_lunch]

It is too bad Makaira partners doesn't do an interview and explain their rationale.  They could probably move the stock if they have a good thesis.  I had never heard of Makaira before it was posted here, for those who don't know the fund manager is semi-famous due to a shout-out from Todd Combs (from berkshire fame).  Given the large (and added to) position from Makaira and cheap valuation, I took a small position on Friday but have to admit I don't know the business at all.  I don't have a good response to the boeing perspective other than these types of competitive pressures always seem to exist for these specialized industrial types of companies.  Somehow they generally seem to pull through.

[handycap5]

i was surprised that wair's margins were as high as they are. this is not a "many-to-many" distribution business, but a "few-to-few" distribution business buying and selling from extremely sophisticated parties, with unusual control by the OEMs (Boeing sometimes buys the raw material for the headwaters of its supply chain).

 

others have qualitatively explained why the margins should remain so high, but i am skeptical...

 

cheers to all the comments above - I really appreciate the quantitative thoughts.

[Patmo]

Ouch, I did a quick calculation and I came to just a hair under 12x EV/EBIT 2014. I have trouble pulling the trigger on things 3x cheaper than this... Too expensive for me despite a nice little growth trend and rosy guidance. Add 50% to EBIT in the next 2 years, it still trades at 7.8x. I don't know how good the quality of this business is, but at this price I'll have a pass without finding out. I'll leave this one for the sharper analysts to decipher.

[BRK7]

Gym97,

 

Thanks for your posts.  I have a couple of questions if you don’t mind.

 

As you know, B/E is in the process of spinning off its “services” business, which will be named KLX.  KLX is the part of B/E that competes with WAIR.

 

Following is a quote from the KLX’s Form 10 filed last month with the SEC:  “During 2013 and 2012, Boeing, a customer in our ASG segment, accounted for 10% and 12%, respectively, of our combined revenue.”

 

WAIR’s most recent 10-K (which relates to year-ended Sept 2013), includes the following language.  “During fiscal years 2013 and 2012 no individual customer accounted for more than 10% of our net sales.”

 

So, I am puzzled by your assertion that B/E “does not supply to Boeing or its Tier 1/2 manufacturers”, and that “WAIR has a disproportionate exposure to Boeing planes.”  These figures suggest that B/E actually has greater exposure to Boeing. Am I missing something?

 

Also, I am curious about your take on the disintermediation issue.  Almost exactly three years ago, New Breed was selected by Boeing to coordinate procurement of commercial aircraft fasteners.

 

http://www.newbreed.com/nb/new-breed-logistics-provide-end-end-supply-chain-management-boeing-commercial-aircraft-fasteners/

 

I think it’s fair to say that this initiative by Boeing has already cost WAIR (and BE/KLX) some business, but what evidence supports your view that this is part of a broader Boeing strategy to disintermediate/eliminate the distribution channel? 

 

Finally, why do you think that the ramp in production of the Dreamliner (after much delay) is a negative for WAIR?  I would think the opposite, given the massive number of fasteners/components needed to build Dreamliner, not all of which will be sourced through Newbreed. 

 

Thanks. I appreciate any insights you can offer.

 

[gym97]

I think in terms of Boeing's runway question, Boeing does not want to pay a significant markup for fasteners. These are specialty fasteners which PCP manufactures spec for Boeing. If you have a predictable manufacturing schedule and extremely predictable demand (20 year backlog), what value does a distributor add? You can have the same working capital benefit and pay no markup sourcing directly from alcan and PCP. In fact, PCP already sells half their fasteners directly to Boeing. It may never get to 100% but I think it can only go up from 50%.

 

With respect to the Boeing question - B/E has historically asserted that they do not supply aggressively to boeing whereas wair has stayed mum. The % you cite from the annual reports are not meaningful given Boeings new dreamliner program is extensively outsourced to subcontractors. The majority of fasteners would likely be used at the contractor level, not the Boeing level (although I could be wrong).

 

Below is a quote from the March 11, 2014 JP Morgan Aviation, Transportation & Industrials Conference:

 

******************

 

Amin J. Khoury

Chairman & Chief Executive Officer, BE Aerospace, Inc.

We do not do much with Boeing at all. Wesco Aircraft, which is a supplier – a distributor in the industry, grew up alongside Boeing and has supplied Boeing for years, as well as Boeing's Tier-1 supply base. And Boeing has, on numerous occasions over the past 15 years, considered going direct – in fact, tried to go direct. And so they're kind of in a battle with Wesco right now to determine whether or not they can disintermediate and go direct to their own supply base. It's not something which impacts us greatly, because our business has basically grown up on the non-Boeing side of the business. So, Goodrich, Honeywell, Hamilton Sundstrand, whole variety of other manufacturers, which we supply and have been supplying, as well as the after-market.

 

So, when we started this business, it was exclusively an aftermarket business, and then it transitioned, where we started doing OE work for the business jet manufacturers, and then the manufacturers other than Boeing. So, Boeing's activities are really directed at Wesco, and they're in a competitive battle at this point in time. And as far as I can see, based on the numbers, Wesco is holding its own.

 

******************

 

Now it would be worth following up with B/E to clarify their Boeing exposure given what they say in their 10K.

 

I think a simplistic way to look at this business is that you have 2 suppliers (PCP and Alcan) and 2 customers (Boeing and Airbus) and you have a middleman that has been earning strong growth margins, growing revenue at a reasonable clip and achieving reasonable returns on capital. Unless you can clearly articulate what the middleman's value proposition will be going forward, i think this the downside might be bigger than the upside at this valuation.

 

[handycap5]

gym97. thank you for an excellent post...one more thing for which to be thankful.

[cpan]

 

gym97, thank you very much for sharing your thoughts. 

[fisch777]

Boeing's "Partnering for Success" Program is trying to squeeze margin out of many suppliers across the supply chain.  Even a behemoth like PCP reportedly has to cede 2-3%/yr in pricing to Boeing.  Even though direct sales to Boeing are X%, the "look through" sales to Boeing (sales to other BA suppliers) is significantly higher: ~40% if I recall.

 

I question if WAIR is a structurally attractive distributor.  The inventory turns extremely slow, which is opposite of what I want in a high-quality distribution businesses.  It seems like WAIR almost serves at "relief valve" for times of elevated aircraft production when a PCP or Alcoa cannot keep up with production rates.  When these "kicker" periods happen, WAIR can charge what they want it seems.  They are constantly having to build up extremely wide SKU assortment with relatively shallow depth of inventory for each SKU, which eats up a lot of working capital, hence the relatively low FCF conversion.  I'm not sure why this will change in the future. 

 

Haas probably is a higher-quality/higher-turn distribution business, despite its lower margins, and probably one reason why WAIR purchased it.

[Guest roark33]

I agree 100% with fisch777.  I read a few reports trying to compare this to Fastenal, but like another poster has mentioned this is a "few to few" distributor.  That never really makes for a great business model.

[gym97]

From what I understand, KLX (BE's distribution arm) is a better business focusing more on repair maintenance and smaller manufacturers (bombardier, defense contractors, etc.) where distributors can add real value to both the suppliers and the buyers. I will keep an eye out on the spin off and hope for some forced selling.

 

[Liberty]

Very nice analysis (gym97, fisch). Understanding the structure of an industry and where a company fits in the value chain is extremely important. I think too many investors overlook this kind of understanding because it's more qualitative than quantitative, so it can be obscured by otherwise good-looking numbers.

[rogermunibond]

Similar type business to aircraft parts is the oilfield parts/consumables distribution businesses of DNOW and MRC Global.  Essentially a duopoly kind of like WAIR and BE's spinoff.

 

I think there's less risk in that area that parts manufacturers will disintermediate.

[Buddy0807]

Decent article on SA on WAIR.

 

http://seekingalpha.com/article/2705755-wesco-compounding-machine-on-sale-40minus-100-percent-upside#comments_header