PKE - Park Aerospace

[Guest Schwab711]

I think there are some cool ideas in the small cap space lately. Here's one I'm ready to talk about.

 

Park Aerospace manufactures prepreg carbon fiber composites, primarily on a sole source basis, for various aircraft models. Composites represent approximately 95% of sales. Although the company has similar qualities to HEI, the company prices its composites such that they earn ~25% incremental EBIT margins on OEM and aftermarket sales. In that sense, this is probably similar to HEI (as opposed to TDG) since PKE will likely not take higher pricing later in the aircraft's life. Given the recency of the company's aircraft program placements, OEM sales are the lion's share of total sales. We shouldn't expect aftermarket sales to be a large portion of total sales if the aerospace industry is growing though.

 

PKE has grown at more than 20% over the three years ended 3/1/2020. Sales will be down this year (like HEI), but PKE will likely be able to take advantage of any broad distress in the industry given that ~50% of its market cap is excess cash. The thesis can be summarized as PKE is a desirable-asset GARP play at a distressed price.

 

Valuation: (at $10.65)

EV/Adj EBITDA: 7.3x

EV/FCF: 11.5x

 

EV is shorthand for MC, ex-cash, here. EV/EBITDA is probably somewhat misleading for potential returns since the company could certainly recap a large portion of equity and create leverage to 10x EBITDA valuation (as opposed to damped returns as PKE revalues to 10x). PKE seems to be punished for its excess cash right now. They've shown they will distribute excess cash to shareholders, if there are no other uses, so looking at the company ex-cash or through the lens of 'highest and best use' seems reasonable to me. If the company had any interest in selling, there would certainly be high demand and they could probably garner a large premium to today's price.

 

Given the desirability and scarcity of quality, small cap aerospace suppliers and the relative valuation, this feels a bit like the setup with PACI. There a buyout seemed more likely, but I expect PKE will do well with almost any recovery outcome. Ultimately, I see low downside and potentially high upside. It's a pretty large position for me.

 

I wrote up something more substantial with an attempt at valuing it today. I assume revenue is down substantially for 2 years before recovery. After recovery, I assume lower growth than PKE has previously realized, despite indications in February 2020 that growth would meet the now-withdrawn guidance.

https://kodakmoats.wordpress.com/2020/06/03/pke-park-aerospace-corp/

[spartansaver]

I owned shares and have very similar thoughts. I decided to sell because I couldn't wrap my head around how aerospace will be in 5 or 10 years. Could be in for dramatic changes. I like the company though, they sell critical pieces on long term contracts that are are fraction of the overall pie. Management seem great and very straightforward. Best of luck in this one, in a few years maybe I'll be kicking myself for selling.

[Guest Schwab711]

I owned shares and have very similar thoughts. I decided to sell because I couldn't wrap my head around how aerospace will be in 5 or 10 years. Could be in for dramatic changes. I like the company though, they sell critical pieces on long term contracts that are are fraction of the overall pie. Management seem great and very straightforward. Best of luck in this one, in a few years maybe I'll be kicking myself for selling.

 

Seems like a fair assessment. The next few years could be rough.

[valueseek]

thanks for the writeup. Management seems solid. My quick take is that they are quite different than HEI not only in the diversity of various businesses at HEI, etc. but also capital intensity. ROIC here or in other words NOPAT - maint. capex over operating tangible assets seems way less than at HEI. When you get a chance, can you please comment on  PKE's ballpark average ROIC - to me it barely looks in low teens but I might have missed something? Thanks.

[Spekulatius]

I think HXL should be the comp, not Heico. Both produce composite parts for aerospace from what I can gather. I like the odds here. Put in a limit order, for some shares, but only got a fill in one account.

[kab60]

Any idea what the normalized economics like? Just taking a quick look at historical ROE, ROIC etc. it doesn't seem impressive even if one haircuts cash balance somewhat but there might be a good explanation for that which could make this very interesting. Thanks for the idea.

[Guest Schwab711]

I think HXL should be the comp, not Heico. Both produce composite parts for aerospace from what I can gather. I like the odds here. Put in a limit order, for some shares, but only got a fill in one account.

 

I think you're right and HXL (and WWD) are the comps I've been looking at personally. I probably shouldn't have done it, but using HEI and TDG seemed like an easier way to generate some interest in the same since most people I've talked to see OEM aerospace suppliers as low margin/low return businesses and only have interest in "aftermarket" sales. It seemed like a high hurdle to climb to try to break this mental model.

 

 

thanks for the writeup. Management seems solid. My quick take is that they are quite different than HEI not only in the diversity of various businesses at HEI, etc. but also capital intensity. ROIC here or in other words NOPAT - maint. capex over operating tangible assets seems way less than at HEI. When you get a chance, can you please comment on  PKE's ballpark average ROIC - to me it barely looks in low teens but I might have missed something? Thanks.

 

The above probably addresses some of the confusion on your end in comparing to HEI. Further, much of PKE's "growth capex" is going to show up as expense through product development in addition to capex on their KS facility expansion. Earnings will likely be somewhat depressed relative to true earnings power.

 

Here's a rough estimate of ROIC on utilized capital.

 

I do a better job in the writeup addressing this, but the thesis is certainly dependent on proper allocation or distribution of the excess cash. I like the excess cash at the moment, but over time it will be a drag on the company's performance if they don't do something with it.

[valueseek]

ok thanks for the clarification and the emphasis on allocation of excess cash.

[kab60]

Thanks a lot for the writeup. I finally came back to digging a little bit deeper and really like what I see.

 

It has some interesting hallmarks in that it screens terribly (which put me away initially when I took a cursory look), while ROIC and growth is actually very impressive. And there's no analyst coverage to speak of.

 

I also very much like managements way of communicating (culture eats strategy for lunch, lol).

 

One thing I'm struggling with is figuring out revenue in the coming years. Do they have any volume commitments from their customers? (it seems like they convinced their biggest customer not to stop taking delivery completely, because it would mess up five years of work). Airbus are slashing production by 1/3 it seems, so perhaps that's a reasonable estimate for the commercial businesses when inventory has been run down?

 

Seems like a case of low risk, high uncertainty, which often results in an assymetric bet. A thing, which nags me a bit, is M&A. These guys are clearly very disciplined, but at the same time they've never actually done a deal and integrated a an acquisition (from what I could quickly find). Considering what seems like a somewhat special culture, that's not necessarily gonna be easy.

 

But perhaps more puzzling: Raging Capital are winding down and offloading their stake in Park (seems to be halfway through). Unless they buy something extremely distressed, isn't that the most obvious M&A for them to do - IE retire some of their own shares?

[kab60]

Seems like Airbus is keeping production of 320neo steady at 2/3 of prior level: https://www.reuters.com/article/us-airbus-production-exclusive/exclusive-airbus-holds-jet-output-stable-in-face-of-crisis-warnings-sources-idUSKCN26F2NA

 

It's an interesting situation, because while good for Parks current business, lower production rates might force more suppliers over the edge and possibly force them into Parks hands. Anyway, it seems like airlines are gonna struggle for longer than what was perhaps initially expected, so I'd think some owners will have to come to the table eventually. I took a position.

[Gamecock-YT]

A thing, which nags me a bit, is M&A. These guys are clearly very disciplined, but at the same time they've never actually done a deal and integrated a an acquisition (from what I could quickly find). Considering what seems like a somewhat special culture, that's not necessarily gonna be easy.

 

But perhaps more puzzling: Raging Capital are winding down and offloading their stake in Park (seems to be halfway through). Unless they buy something extremely distressed, isn't that the most obvious M&A for them to do - IE retire some of their own shares?

 

This has been my biggest hang up on buying. When I was doing some work on PKE I didn't get a good feeling for how they would look at capital allocation decisions. They have a bunch of niche product lines and speak about always wanting to get in the action, no matter how small the project is. The CEO seems interested in buying a company with the cash they have but never really gave any details on what specifically they are looking for, just that the had engaged their investment bankers and they were advising holding off until companies got into more distress. There was a question on buybacks but the CEO was signaling they'd consider it if the price dropped in the mid single digits....

 

With the excess cash sitting on the balance sheet, this just looks too ripe for a private equity group or Transdigm coming in and levering it up. The engine covers seems to be the product that's going to butter the bread of the company going forward. My guess is the price will continue to languish with the share overhang. Maybe good time to buy is when they start buying back shares given how conservative they seem to be.

 

 

 

[kab60]

I think they've been pretty clear that they target something niche (he doesn't want to get into high profile programs like f35 due to political risks). And I like the discipline in that he seems to constantly turn down investment bankers (they mus hate such a cheap skate). They've also shown they very much think of shareholders and have returned a ton of cash, so it's not a big concern of mine, I just thought buybacks is so obvious their weak response is puzzling. But perhaps they have some targets in their crosshair. So I think we're in good company - worst case they buy a dud or return the cash. But if they get a good deal, fireworks could explode down the line (agree it is an obvious LBO candidate, but that is not a bad spot to be in though I doubt that is a route they'll go).

[whistlerbumps]

I agree M&A is a critical issue here.  The hope is that their partners push something distressed to them that is a good fit.  Brian is certainly patient so the risk to me is more that the cash sits around and they miss the chance rather than they overpay for an asset.  We will see though.