Hexcel Corporation

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Hexcel Corporation is a global advanced composite technology company, specializing in lightweight materials used in aerospace, defense, and industrial markets.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Hexcel’s economic moat, while present, is not as wide or impenetrable as some of its peers in more specialized markets. Its moat strength rating is 3 out of 5. This evaluation is based on several factors that will be detailed below:

Business Explanation:

  • Revenue Distribution:
    • Commercial Aerospace: This is Hexcel’s most significant revenue contributor, accounting for approximately 70% of sales in 2023. The company’s products are used in airframes, engines, and other interior structures. Demand is largely tied to commercial airliner production and deliveries.
    • Space & Defense: Approximately 24% of 2023 sales were from this segment. Hexcel’s products are used in military aircraft, helicopters, and space vehicles. This segment is driven by government spending and defense budgets.
    • Industrial: This segment is the smallest, at approximately 6% of sales in 2023. Here, Hexcel’s materials are employed in high-performance industrial applications like automotive and sporting equipment. This sector tends to be more fragmented and price-sensitive.
  • Trends in the Industry:
    • Aerospace Recovery: The commercial aerospace sector is recovering from the COVID-19 pandemic’s impact, driven by a rebound in air travel. There is a growing demand for new, more fuel-efficient aircraft that utilize lighter composites.
    • Defense Growth: Defense budgets are increasing due to geopolitical tensions, creating steady demand for advanced materials.
    • Sustainability: The emphasis on sustainability in automotive and other industries is leading to increased use of lightweight composites.
    • Supply chain constraints: Both industry and company are impacted by long lead times, rising supply costs, and transportation issues. The management is working to mitigate it, but effects remain a notable part of the performance.
  • Margins:
    • Gross margins averaged around 25.5% in 2023, while adjusted operating margins were ~14.4%. The margins are relatively solid, but can come under pressure from material costs and supply chain issues, and are not necessarily stable or consistently growing.
  • Competitive Landscape:
    • Hexcel competes with a number of large players in the aerospace industry. However, as a leading player with a well established customer base and long-term relationships, they are well positioned within this market.
    • In Industrial market, they face smaller manufacturers of carbon composites, and the pressure on price is higher than in aerospace.
    • The industry as a whole is very concentrated, with very few suppliers and large customers.
  • What Makes Hexcel Different:

Hexcel’s core competencies include high-performance composite technology, particularly in carbon fiber and its applications. This is not a manufacturing commodity, but a specialty field that requires significant technical expertise. They utilize vertically integrated manufacturing to reduce dependency on upstream suppliers and achieve better cost control. They boast strong, long-term relationships and partnerships with big aerospace players. However, they do rely on few suppliers, which increases risk.

Moat Analysis:

  • Intangible Assets (Brands and Patents): Hexcel does not have particularly strong brand recognition in most markets (save for some in the niche market space) and their patents are of limited duration, therefore a narrow, instead of wide moat.
  • Switching Costs: While Hexcel’s products are highly engineered, the direct cost to switch to competing manufacturers is not particularly high for its customer base. However, the indirect costs related to recertification, requalification, and retooling result in moderate switching costs. This helps improve revenue visibility but is less of a moat in comparison to other companies.
  • Network Economics: Hexcel does not benefit from any network effects since the value of their products is not increasing with the number of users.
  • Cost Advantages: Hexcel’s cost advantage is more a product of the manufacturing process and vertical integration than outright low-cost access. They operate highly capital-intensive facilities but produce high-value specialized products.
    • The recent acquisitions in the carbon fiber industry have strengthened the company as a leading player.

Legitimate Risks to the Moat and Business Resilience:

  • Technological Obsolescence: As newer materials and processes develop (such as advanced metals), Hexcel faces the risk of products losing demand.
  • Industry Cyclicality: Hexcel is highly exposed to the aerospace industry, which is cyclical. This makes their revenue projections vulnerable to air travel demand, commercial air-manufacturing capacity and government budgets.
  • Supply chain disruptions: A lot of their value resides in their expertise in carbon composites. However, raw material supply and transportation costs can create temporary disruptions and affect profitability.
  • Customer Concentration: A large portion of revenue comes from a limited number of large customers. Loss of key contracts or reduced demand from these customers could severely affect their business.
  • Competition: Despite its technical expertise and supply chain, Hexcel is not a monopoly and it faces intense competition. Furthermore, the increasing scale and sophistication of competitors will pose challenges to future profitability.

Despite these risks, Hexel’s management is working towards mitigating the above factors.

  • Hexcel is focusing on increasing production rates at existing facilities to meet the demand and avoid any loss in efficiency.
  • The company’s backlog represents stable revenues in future.
  • They are looking to develop new and lighter product portfolios with the help of its R&D spending.
  • Management is planning a 17% increase in capacity in the coming years.

Financials Deep Dive:

  • Revenue: The company’s net sales have grown significantly and are back to pre-pandemic levels, showing steady growth since 2020. The overall revenue grew from $1.2 billion in 2019 to $1.8 billion in 2022, a robust compounded annual growth rate. In 2023, the company posted $1.9 billion revenue, a single-digit growth rate compared to the previous years, highlighting the slow down in demand.
  • Profitability:
    • Gross profit rose to $487 million in 2023, a 25.5% margin. This shows the ability to consistently produce at a good margin. The gross profit has risen from $310 million in 2020 to almost $500 million in 2023, highlighting the recovery from COVID, the margin percentage has stayed mostly stable.
    • Adjusted operating profit at 14.4% in 2023 shows a strong operating structure, which can be further optimized.
  • Cash Flow: The company generated $318 million in cash from operating activities, with a capital expenditure of around $150 million. Free cash flow, is around ~$170 million, which is strong, which gives the company ample liquidity to finance operations.
  • Balance Sheet: * Hexcel’s cash balance is at $336 million as of December 2023, and while long term debt is at ~$1.8 billion. This indicates a strong balance sheet with good liquidity, and while leverage is above-average, is not an extreme concern. Total debt to capital ratio is approximately 68%. * The company continues to focus on debt paydown and share buybacks.
  • Guidance
    • The company has released positive guidance for next years earnings, expecting continued growth.

Understandability Assessment: The company’s business model can be described as moderately complex (a 3 out of 5 on the understandability scale). They sell highly engineered materials for specialized applications, which require some knowledge and due diligence. It’s not simple to fully grasp why one material is preferred over another, and a deep dive into the technical aspects of their products is important to understanding the competitive advantage. This, combined with the need for assessing the commercial aviation industry and defense policies for revenue forecasting makes this business moderately complex.

Balance Sheet Health Assessment: The overall balance sheet health is rated at a 4 out of 5. Hexcel has a robust liquidity, which gives flexibility to pursue growth and acquisitions. The debt to capital ratio is relatively high, though management seems to be working on that. Cash reserves provide a safety buffer to weather downturns and mitigate some of their risks. The company’s financial statements seem consistent and it is well positioned to generate increasing free cash flow in coming years.

Final Thoughts

Hexcel Corporation is a good company and its revenue has made great recovery since COVID downturn. The company’s reliance on few customers and industries makes it somewhat risky, the competition is also intense and has to be kept in mind before making a long term investment. The main moat, while present, is based more on expertise in composite production, specialized products, and vertical integration, making it a narrow rather than wide moat. However, there are indications that this moat could widen given the tailwinds from defense sector, sustainability, and aerospace industry recovery.