StandardAero, Inc

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

StandardAero, Inc. is a leading independent provider of maintenance, repair, and overhaul (MRO) services for commercial, military, and business aviation engines and their components.

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 StandardAero operates primarily as an independent MRO provider for aircraft engines and components. This means they service, repair, and maintain these critical parts, rather than manufacturing them directly. Their services are essential to keeping aircraft flying safely and efficiently, catering to a diverse range of customers across commercial, military, and business aviation sectors.

Their service operations primarily consist of 3 segments: 1. Engine Services: This is their largest segment, which involves scheduled and unscheduled maintenance, repair, and overhaul (MRO) of aircraft engines. This includes inspection, cleaning, component replacement, and performance testing, among other services.

Component Repair Services: This segment focuses on the repair, maintenance, and overhaul of engine components, as opposed to entire engines. This could involve anything from individual compressor blades to control systems. They have particular expertise in specialized materials and processes, including exotic alloys.

Airframe Services: This segment focuses on services such as airframe maintenance and repairs. It’s more of an extension of their existing MRO capabilities, with the services centered on the airframe. 

The company’s expertise extends to a variety of engine platforms, from large commercial jet engines to smaller turboprops.

Notably, StandardAero positions itself as an OEM-aligned independent provider. This means they provide maintenance services that meet the rigorous quality standards of original equipment manufacturers (OEMs) such as Pratt & Whitney, GE, Rolls-Royce and other major aviation engine manufacturers.

Industry Trends and Competitive Landscape The MRO industry is highly specialized and requires significant technical expertise and regulatory knowledge to operate. The primary drivers in the industry include:

Aging Aircraft Fleets: As aircraft fleets age, the demand for MRO services increases. This creates recurring revenue for firms like StandardAero.
Regulations and Compliance: Stringent safety and environmental regulations require regular maintenance and repairs. This increases the importance of having a reliable MRO partner. The aviation industry is under the oversight of various regulatory bodies globally such as FAA, EASA, and other regional bodies. The stringent regulatory environment creates high barriers to entry and allows existing players such as StandardAero to stay relevant for long.

These regulations, while beneficial in terms of safety and quality, also translate to a substantial need to stay at the cutting edge of new certifications and practices, a costly undertaking that might weigh negatively on future earnings and free cash flow.
- Technological advancements: Engines and parts are becoming more technologically sophisticated, requiring even greater knowledge and infrastructure for maintenance and repair.

While technological advancements enable companies to create better products and services, they might also cause their services to lose relevance as newer more efficient planes that are less intensive in repair and maintenance are used by airlines and other related companies.
Airline Profitability and Capacity: MRO demand is influenced by airline profitability and capacity utilization. When airlines are more profitable, they invest more in MRO, conversely, when airline capacity is lowered, their MRO volumes decrease.
Market Consolidation: Consolidation in the airline sector, as well as OEM engine manufacturing, influences who wins new MRO contracts and how much volume it is likely to generate. However, these shifts in the industry rarely destabilize or cause sudden changes in the MRO industry.

The competitive landscape in the MRO industry is a mix of large, OEM-linked companies, airlines with their in-house MRO operations, and other smaller independent service providers. The key differentiators in this landscape include:

Technical Competence & Certifications: MRO providers are valued for their expertise in maintaining a wide range of engines and parts, which are rigorously regulated, therefore having a wide scope and range of accreditations is paramount.
Turnaround time & Delivery times: Airlines value quick turnaround times to minimize aircraft downtime.
Geographic presence: having a global or widespread regional network is important for the MRO industry, as they need to be close to their customers and to be able to service them in a short timeframe.
Pricing and relationships: pricing and quality of services is very important as there is a delicate balancing act when customers rely on these suppliers.

What Makes StandardAero Different?

OEM Alignment: Unlike many independent MROs, StandardAero emphasizes close relationships with OEMs. This allows them to maintain high service standards and work on newer, more advanced engine models while still being independent.

Global Presence: StandardAero’s network of service facilities in North America, Europe, and Asia makes it easier to serve customers from varied locations. Having a geographically diversified portfolio allows them to be more stable than competitors, due to lower reliance on one particular geographic region.
- Full spectrum service: StandardAero provides an end-to-end range of services from engine MRO to component and airframe servicing, and this makes it a more convenient and easy choice for customers.
- Highly diversified business: StandardAero works for a wide variety of clients in different sectors including Commercial aviation, business aviation, and the US government.

Financial Analysis StandardAero’s financial position is best understood via insights from their latest quarterly reports and their last registration statement.

Revenue: The company’s revenue growth is mostly tied to growth in air travel and defense budgets, both are volatile factors, as can be seen with the recent COVID-19 pandemic which led to lower aviation activity.
- The revenues were reported to be $3,638 million in the year ended December 31, 2021
- Revenues were $3.879B for the year ended Dec 31, 2022
- Revenues were $1.119B for the three months ended March 31, 2023
- Revenues are driven by a mix of fixed fee contracts for scheduled events (such as engine overhauls) and time-and-material contracts for unplanned events.
Gross Profit: StandardAero boasts consistent margins, which range between 28% and 32% which show its efficient operations. * Gross profits for year ended December 31, 2021, were reported to be $1.083B * Gross profits for the year ended December 31, 2022 were $1.221B
Operating profit: Operating margins, defined as EBITDA over total revenues have seen a steady increase over recent years, improving from 11.7% in 2017 to 17.3% in 2021 and 18% in 2022.
- Operating profits for year ended December 31, 2021, were reported to be $624 million
- Operating profits were $702M for the year ended December 31, 2022. * Operating margin has varied historically (19.2% in 2019) as the business ebbs and flows with macro-economic trends and is affected by acquisitions (2021 had operating profits of 18%).
Net income: StandardAero has historically been a profitable business, with 2021 net income of $160M which increased to $234M in 2022.
- Net income was $57 million for the three months ending March 31, 2023.
Balance Sheet:

Assets: StandardAero has a fairly large asset base consisting of properties, plants, and equipment (roughly $3B). They are often leased, as shown in their latest report. StandardAero also has a substantial amount in intangibles due to past acquisitions, roughly $1B. They also have a good cash and cash equivalents balance at around $500 million.
- Liabilities: StandardAero’s most prominent liabilities include debt and operating leases. * Long-term debt was roughly $2.5B in 2022, down slightly from 2021.
  - Operating leases were around $740M in 2022.
- Equity: The company’s equity stands at a little over $1.6B in 2022, largely influenced by past profits and shareholder investments.
- Cash Flow: The company’s cash flows remain a mixed bag. In FY 2022, they reported $788M in operating activities and $324M in free cash flow. A lot of this capital spending goes towards maintaining and expanding its current operational capabilities. They also spent around $418 million in acquisitions.
  - As at March 2023 quarter, cash from operations was reported at $307M and free cash flows were $143M.
Management Commentary
StandardAero CEO, Russell Ford, acknowledged in the latest earnings call, that the business is doing very well in terms of long-term prospects for the aerospace aftermarket business but that they are seeing some impact to business due to supply chain constraints. They see this as a temporary hurdle, and they have found ways to circumvent it, by working more collaboratively with their suppliers and even providing financial assistance to them to ensure that their supplies reach them.
StandardAero also noted that the recovery in the Business Aviation sector was faster than in the Commercial Aviation sector.

The new Credit Agreement that was entered in 2022 significantly increased the liquidity available to StandardAero to pursue acquisitions and future growth objectives.
StandardAero highlighted that they are pursuing further growth through expansions in service capabilities, new markets and strategic acquisitions.

Moat Rating: 3 / 5 StandardAero has a “Narrow Moat”. Here’s why: * Barriers to Entry: The MRO industry has high barriers to entry given the specialized skills, certifications, and large capital investments required. New entrants have to overcome all of this and develop a history of high quality and long experience, which is really difficult. * Switching Costs: While not extremely high, customers tend to stick to MRO providers with established track records due to the high safety and compliance requirements. This creates some switching costs, which is a characteristic of a moat. * Scale Advantages: StandardAero is one of the larger independent MRO players, which gives it some scale advantages in terms of operating efficiency, delivery times, and the ability to maintain a large global network.

Intangible Assets: StandardAero does not necessarily have very strong intangible assets such as brands or patents, and its services are often commoditized in that it does not have any IP.

However, a global footprint and close partnerships with OEMs, as well as having a global scale, are intangible assets of importance.
Weaknesses:
- The reliance on air traffic means that MRO firms are prone to industry swings in the aviation industry. Airlines will be cutting spending, as they try to reduce costs due to decreased consumer spending.

Supply chain issues related to increased lead times may lower profits, make it more difficult to get the right tools at the right time, and affect delivery dates, directly impacting overall profits
- MRO services are typically commoditized, so there is fierce price competition, which can erode profit margins.
Understandability: 3 / 5

StandardAero’s business model is moderately complex. While the core concept of providing maintenance services is straightforward, their diverse operations, reliance on regulations, and financial structure can be more complex for those not well versed in accounting or finances. Additionally, their growth strategy includes organic and inorganic growth, often through acquisitions, that can complicate valuations.

Balance Sheet Health: 4 / 5

StandardAero has a good balance sheet. Their balance sheet is fairly straightforward. However, their debt is something that needs to be watched over the coming years, given higher debt rates. At the same time, they are well positioned to keep delivering positive cash flow. Their assets also provide strong intrinsic value and a solid base for operations.
Their revenue and cash flows are expected to grow, albeit slightly, over the coming quarters.
Their strong free cash flow gives them options in terms of capital allocation, growth, debt repayment, acquisitions, and returning cash to investors.

StandardAero’s current strong cash position also gives a cushion in terms of any potential economic downturn, or downturns in the aviation and defense industry.

Risks to the Moat * Technological Disruptions: New engine technologies or material sciences could require less maintenance or completely change the MRO process, potentially rendering some of StandardAero’s capabilities obsolete. * However, StandardAero’s close ties to the OEMs should protect them from obsolescence in terms of technical knowledge and implementation. * Industry Consolidation: Increased consolidation in the airline or aircraft engine manufacturing sectors might result in the creation of more in-house maintenance capabilities, creating a smaller market for third-party MROs. * However, StandardAero’s current customers are all fairly large, so having a more well-defined market might actually help them.

Pricing Pressures: Increasing competition could lead to pressure on prices, eroding profit margins. As it’s a very mature industry, it’s very easy to fall into a price war if a newer company undercuts on pricing. This means that while the moat might protect them from competitors it’s not foolproof in maintaining profitability if an external player attempts a price war.

Rising Operational Costs: A rise in operational costs, such as labor or fuel, could threaten the company’s profit margins and competitive advantage. This is particularly a problem in a highly inflationary environment.
- StandardAero has not historically had much problem with rising labor and material costs, but if inflation stays high for long, this might prove to be a real problem in coming years.
Regulatory Changes: Changes in aviation regulations, especially those regarding maintenance, could impose new costs and requirements, and some regulatory changes might directly affect their business and ability to perform key MRO services. * The company’s close ties to various governing bodies may give them a head start and an advantage in terms of navigating regulatory issues. * Acquisition integration: While it’s a strategic objective, the integration of acquired companies might be challenging and may not yield expected results.

Financial Risk: There is the risk of excessive leverage from acquisitions, that can create financial problems for the company, leading to a decreased ability to operate profitably, especially in an environment with high-interest rates.

Conclusion

StandardAero, Inc. shows promising qualities in generating sustainable returns, operating in an industry with substantial barriers to entry and potential for continued growth, especially within its current segments. It has carved out a niche through specialized services, large scale, and close OEM relationships, but it remains prone to competitive pressures, macroeconomic forces and the volatility of air traffic that may erode potential profits. While it’s not perfect, its narrow moat combined with reasonable growth prospects and stable cash flow makes it worth taking a deeper look at for any investor who is comfortable with the aviation industry.