Loar Holdings Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Loar Holdings Inc. is a diversified aerospace and defense manufacturer specializing in highly engineered components with a focus on niche 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.

Business Overview and Competitive Landscape

Loar Holdings Inc. (LOAR) is a specialized supplier in the aerospace and defense industry, primarily focused on manufacturing complex components for both commercial and defense aircraft. These components include airframe parts, engine components, power systems, and other mechanical and electronic parts.

LOAR’s strategic advantage lies in its ability to produce difficult-to-manufacture parts and deliver them on time while adhering to rigorous quality standards. The company is not vertically integrated, instead relying on a global network of suppliers, with over 90% of sourcing done in North America. This positioning allows them to navigate supply chain challenges with relative agility compared to peers that source from distant locations.

The aerospace and defense industry is characterized by a complex supply chain and stringent quality requirements. Competition ranges from large, diversified manufacturers to smaller, specialized producers. It is also impacted by government and regulatory decisions which adds an additional level of complexity.

LOAR’s main end markets are:

  • Commercial Aerospace: This is approximately 45% of their sales and includes the design, manufacture, and supply of component parts for commercial aircraft. Key players in this market include Boeing, Airbus, and Embraer.
  • Defense: This market is approximately 55% of their sales. LOAR manufactures and supplies components for the U.S. Department of Defense. Major clients include companies like Lockheed Martin and Raytheon.

It’s important to note the increasing convergence between commercial aerospace and defense markets. Companies and the tech they have used in either one are being adopted in the other. This is increasingly blurring the lines of “defense” and “commercial” markets.

The aerospace and defense market generally requires a high degree of expertise and capital to succeed, as well as long standing relationships with major players. Competition is high and contracts are hard to obtain and maintain, and it’s a highly regulated industry.

Moat Assessment: 2/5

LOAR’s competitive advantage primarily revolves around:

  • Proprietary Technologies & Intellectual Property

LOAR designs and develops products with specialized features and capabilities, which are often protected by patents and proprietary know-how. This creates some level of differentiation but is vulnerable as patents expire or competition develops alternatives. The nature of their components also means that the same component will be replicated across different designs, thus the design can be adapted by competitors after enough time.

  • Industry Experience and Long-Term Relationships

LOAR has been operating for over 30 years and has developed long-term relationships with major OEMs. This reduces the risk of new entrants, but established competitors can still attempt to displace them. Moreover, long term contracts don’t assure long term value. If the performance is poor or the quality is not up to mark, OEMs may simply choose a different provider.

While these aspects provide an edge, the level of differentiation is moderate, and long-term contracts don’t imply guaranteed business for the future. The barriers to entry for others are high for newer entrants, however, this is not a guarantee against existing competitors, whom all have equally strong relations, manufacturing setups and capital resources and could compete for the business as contracts come up for renewal or for new business.

Furthermore, it’s easy to see how in this industry with its relatively stable end market, the companies may end up all offering products at prices very close to the others, as customers seek out the best deals and there is no differentiating factors. This can easily put pressure on the margins and returns on capital.

Moat Rating: 2/5

  • Justification: LOAR’s moat is considered narrow rather than wide due to the fact that a lot of its competitive advantages are susceptible to be replicated or attacked. Its competitive advantages are good for generating revenue, but those revenues can fluctuate. As mentioned earlier in the report, the company operates in a competitive industry with multiple large players and very strong players. The pricing power the company has is moderate and may fluctuate depending on the contracts signed and the market dynamics.

Risks to the Moat and Business Resilience

Several risks could impact LOAR’s moat and overall business performance:

  • Customer Concentration: A significant portion of LOAR’s revenues is derived from a few key clients, making the company vulnerable to a loss of a major customer or shifts in major OEM supply chain policy. While the company has long-term contracts, it does not remove the risk of losing a customer, or losing share of a specific contract.
  • Government Regulations: LOAR is heavily dependent on the governments that they work with. Major changes in trade policies, tariffs, and governmental funding could materially impact their business. If the government has a dispute with any of the countries that LOAR operates in, that might have an impact on its revenue and profits. Moreover, the sector is exposed to a constantly changing environment of laws and regulation.
  • Competitive Pressures: The industry is highly competitive, and price pressure from competitors could erode margins, even if they have a defensible technology or process. This industry might see big consolidation among key players over time, or new companies could emerge who take a significant portion of the market.
  • Technological Obsolescence: There is constant innovation in the aerospace and defense industry and LOAR must continually evolve its products and processes to maintain a competitive edge. If the technology moves too far away from their current setup, the company may face huge costs in order to upgrade it and would probably be behind its competitors.
  • Acquisition Risk: A lot of LOAR’s revenue has come from acquisition, and they do a lot of integrations that consume resources. If LOAR misses on its acquisitions, or fails to integrate them effectively, then that might impact profitability negatively. Moreover, acquisitions in highly competitive markets do not guarantee an expansion of the moat. Often, overpaying for acquisitions to increase the top line revenue, has had negative impact on the margins, and profitability, and if these acquisitions fail to meet expectations then those companies may see massive write-offs which would also hurt the company’s bottom line.
    • Supply Chain disruptions: LOAR depends on complex and global supply chains, and any disruption to them (political instability, natural disaster, or supplier issues) could negatively impact revenue and profitability.
  • Financial Risks: As a highly leveraged company, rising interest rates may make it harder for LOAR to meet its interest payment requirements and could impact its value. Moreover, the debt is secured and thus could be called back if LOAR struggles.

Business Resilience:

  • Strong Backlog: Despite the risks, LOAR maintains a strong backlog of orders, which should provide a revenue floor for the next few years.
  • Cost Efficiency: Its cost structure and global sourcing strategies offer certain advantages, although this may be offset by competition.
  • Diversification: The company’s products and its clients are somewhat diversified, which makes it resilient to some extent.

Financial Analysis

Income Statement:

  • Revenue Growth: LOAR has seen revenue growth mainly through acquisitions. For the year ended December 31, 2022, LOAR reported net sales of $780.3 million, compared to $334 million in the same period of 2021. The majority of this increase (69%) is attributed to the acquisitions, with a small portion being organic.
  • Margins: Gross profit margin was 34.9% for 2022 (excluding the effect of impairments), vs 46.1% in 2021. The decrease is because of large acquisition costs and write offs. Adjusted EBITDA was 24.7% compared to 28.2% for the previous year. The decline shows that though the company can generate a decent operating profit, it is not immune to downturns and price pressures. The margins might also erode due to the debt that the company carries and thus the required interest payments.
  • Profitability: The company saw a net loss of 117.2 million dollars in 2022, compared to a net income of 56.8 in the previous year. The loss was driven by interest expenses, amortization costs and loss on sale of assets. The company can have strong profits only if those issues are ironed out.

Balance Sheet:

  • Assets: Total assets increased to $1,075 million in 2022, from $556.3 million in 2021, which was a result of the company’s acquisitions. A significant portion of the assets are intangible assets related to goodwill and patents. The current assets are $282.4 million, including cash and cash equivalents of $32.6 million.
  • Liabilities: Total liabilities were $752.1 million in 2022 (including operating leases and debt), from $234 million in the previous year. Long-term debt accounts for a significant portion at $539.5 million. As interest rates increase this would heavily burden the company. Current liabilities are also high at $215 million.
  • Equity: Total equity stands at $333 million. The level of assets compared to equity and the associated high debt level, indicates a risky balance sheet and an elevated risk for investors.

Cash Flow:

The cash flow from operating activities is negative ($83.9 million), as the company faced a massive dip in net income. However, the cash balance is not low and the company can meet current obligations, and the operating cash flow is expected to return to positive for the future. The company has raised capital in 2022 ($325 million) so they have been managing to increase their cash resources.

Understandability: 3/5

LOAR’s business model is relatively straightforward, they buy companies to generate revenue. It is also clear that the company manufactures complex parts for the aerospace industry. However, the company has a complex accounting structure involving several adjustments (like fair value and goodwill related to acquisitions), and a lot of complicated contracts, which make it somewhat hard to analyze at first glance. A beginner investor or an average person might take time to fully understand this business and all its nuances. There are a few moving parts.

Balance Sheet Health: 3/5

LOAR’s balance sheet is somewhat concerning, primarily because of its very high debt load. The company has a good portion of its asset side also made of intangible assets and goodwill, which further reduce the quality of the assets. Though, the cash balance is adequate to cover obligations and the company is able to generate positive free cash flow in most cases, the level of debt and its related obligations put it at risk, especially in a downturn in the economy. The company might also need to sell off some valuable assets if the loans fall due, thus further harming the balance sheet. However, the company has recently been doing steps to reduce its debt which makes its balance sheet a bit more healthy.

Recent Concerns and Management Outlook

A recent SEC filing (LOAR Holdings Inc., Registration Statement) shows a share dilution of roughly 15% of outstanding shares. This shows the need for the company to raise money. However, the management has said that the money will be used for “ general corporate purposes”, which in simple terms means the money can be used for acquisitions, covering debt, or anything else. As the share prices already took a dip during the past earnings report due to the management noting lower revenues, and this dilution will further reduce the price, this is a cause for concern for investors. This signals that the management does not have a clear roadmap for how to generate profits and value for its investors, and their reliance on acquisition will continue.

Moreover, in the same report and in their investor relations calls, LOAR management highlighted their ongoing focus on “strategic integration” of recent acquisitions, working on margin improvements, and continuing to generate organic growth. While this sounds reasonable and is also reflected in the projections of the company, they have also mentioned a few headwinds. LOAR faces uncertainties in aircraft delivery schedules (due to the overall macroeconomic conditions), and that their supply chain still faces pressures.

In conclusion, LOAR appears to be a company with a moderately narrow moat that needs to be carefully monitored due to the complexity of its financials and the challenges it faces, especially in the face of aggressive acquisition plans and debt. While there are opportunities for growth, investors need to weigh both the risks and rewards carefully.