Spirit AeroSystems Holdings, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 2/5

Spirit AeroSystems is a global tier-one manufacturer of aerostructures, primarily for commercial and defense aircraft, serving both Boeing and Airbus.

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

Spirit AeroSystems (SPR) is a major player in the aerospace industry, focused on designing and manufacturing a variety of complex aircraft structures. The company operates through two segments:

  • Commercial: This segment involves the production of fuselage sections, wings, pylons and other parts used in commercial aircraft. Boeing and Airbus, the two largest commercial aerospace companies, are the main customers for this segment, and have a significant impact on SPR’s sales.
  • Defense & Space: This segment designs and manufactures structures for defense-related programs. It includes wing components, fuselages, and structural assemblies that are used in military aircraft.

Revenue Distribution

The company’s revenue is highly concentrated, with the majority of its revenue derived from contracts with its two primary customers, Boeing and Airbus. This exposes Spirit to risks stemming from production fluctuations or economic challenges faced by these aerospace giants. The company has recently been trying to expand its revenue base through acquisitions and diversification within its portfolio. For the nine months ended September 30, 2022, SPR generated revenue:

  • Commercial: $2,699M
  • Defense and Space: $1,400M
  • Aftermarket: $608M
  • Total = $4,708M

It’s important to note that about 88% of the net sales of 2022, came from the sale of products or services manufactured in the U.S., with approximately 67% of the revenues generated being tied to Boeing.

The aerospace industry is characterized by high barriers to entry, extensive lead times, and substantial capital requirements. It is also a cyclical industry, with demand for aircraft closely linked to global economic health, passenger travel, and fuel prices. The industry has only a few major companies, Boeing and Airbus, controlling a considerable market share, and thus supply chain companies like SPR, operate in a duopoly market.

  • Competition: Spirit competes with other major aerospace manufacturers, some of which also have long-term contracts with Boeing and Airbus. For example, there are other tier 1 suppliers, such as Leonardo Aerostructures, Safran, and others, competing for the same contracts as Spirit.
  • Industry Consolidation: There is a trend of consolidation among industry players, including mergers and acquisitions, which can impact smaller players. Spirit has tried to get ahead by acquiring certain technologies and capabilities, but it’s still very early to see if it will give the expected results.
  • Technological Advancement: The industry is rapidly changing and adopting new technologies in manufacturing processes, new materials, and designs, and the company has to keep up to date with those changes and also implement them. Failure to do so might lower the competitiveness of the company compared to its peers.
  • Government Regulations: The aerospace industry is heavily regulated and is subject to oversight from government entities around the globe. These regulations cover air safety standards, environmental requirements, and export rules. Any changes can have a substantial effect on the operations of the company.

What Makes the Company Different

While Spirit is not unique in many aspects, it differentiates itself through:

  • Scale and scope of operations: Spirit is one of the few companies that are capable of making a wide variety of large components and modules for a variety of aircraft programs and has a huge factory. They are also trying to expand to different markets, like MRO and aftermarket services, to balance its revenue base.
  • Long-term relationships: Spirit’s relationships with Boeing and Airbus are long-term commitments, with extensive contracts that can go up for more than a decade. However, this is also a risk, as the dependence on only two major companies exposes Spirit to a lot of risks.
  • Focus on Innovation: The company has focused a lot on developing new technologies and manufacturing processes to improve its product offerings.
  • Supply Chain Integration: One of the main aspects of Spirit is its focus on integrating the design and manufacturing of its products. This allows it to manage the supply chain more efficiently.
  • Vertical Integration: Though not as much as Tesla in the automobile market, Spirit is vertically integrated and can produce many products in house.

Spirit needs a lot of capital to stay afloat and compete. The most important aspect for its future prospects is to bring stability in the operations and deliver consistently good products to its customers.

Moat Analysis: 2 / 5

The “moat” concept, in this context, refers to the competitive advantages that protect a company’s earnings from competitors. Spirit’s moat is weak, due to a combination of factors.

  • Intangible Assets (Brands, patents, regulatory licenses): 1 / 5 Although Spririt manufactures parts for aircrafts, they do not have a visible brand associated with them. Further, since most of the work is production of other people designs, they do not have many patents, they only have some proprietary technologies that provide it with some advantages. The certifications required to supply aviation parts is a barrier to entry, but those certificates are relatively easy to acquire if you have the ability to manufacture those parts.
  • Switching Costs: 2 / 5 Switching costs in this market are not high. If a new supplier can meet quality and cost requirements, both Boeing and Airbus will happily switch. The fact that the long term contracts gives stability to the business is a benefit, but this also creates higher switching costs. Further, as the design and manufacture of components is done closely with the clients, companies must start almost from zero every time they find a new provider, leading to switching costs.
  • Network Effect: 1 / 5 Network effects are largely absent from this business model, even though the company is a large player in the market. The connections between companies in the supply chain doesn’t create any real competitive advantage for the company.
  • Cost Advantages: 2 / 5 Spirit has cost advantages arising from economies of scale, lean production, supply chain integration, and manufacturing capabilities. But other companies can implement similar production strategies and create similar products, making the competitive advantage limited. Also, since labor is only part of their cost structure, other companies that are based in areas with lower costs could be a serious challenge. Further, they are a manufacturer, and this means competition on pricing will always be there.

The two points where the company has a better moat is switching costs and cost advantages, but these two parts are also weak because, at the end, the price the products is given by a small number of customers, making switching possible and the cost a matter of competition.

Risks to the Moat

Spirit faces various risks that could erode its moat:

  • Customer Concentration: Spirit’s dependence on Boeing and Airbus, means it is exposed to risks of reduction in orders from one of them. Even if it can supply Airbus, the production capacity is very different between Boeing and Airbus and the company might not adapt very fast to changes. Further, there is always the risk of the companies deciding to produce these components in house, effectively eliminating SPR from the business.
  • Technological Disruption: The rapid pace of technological change and the shift toward more efficient or sustainable aircraft technology is a challenge for the company. Inability to adapt will render its processes, product, and capabilities obsolete, leading to financial harm for the company.
  • Supply Chain Disruptions: Like most manufacturers, Spirit is affected by the supply chain, and is vulnerable to disruptions that might cause production delays, increase costs, and also affect long-term planning. A lot of inputs for producing its products may be provided by other companies and if their production is compromised, SPR may also have problems.
  • Operational Failures: Production delays, cost overruns, and quality issues can damage the company’s relationships with its customers, and thus reduce the value that a moat brings to the company.
  • Economic Cycles: The demand for aircraft fluctuates with the overall economy and travel demand. Economic slowdowns lead to reduced orders for aircraft, and consequently a decline in revenue for Spirit.
  • Increased Competition: The company is continuously exposed to competition from other companies. Increased competition in the aircraft component market can drive down profits and make it hard for the company to maintain high ROIC over a long term.
  • Labor Cost: High union density within the company means it can be susceptible to higher labor costs and issues related to labor relations.

Business Resilience

Despite having a weak moat, Spirit is somewhat resilient due to:

  • Long-term Contracts: Long-term contracts with major players provide consistent revenue and also ensures certain stability in the business, but it is not always a guarantee for survival.
  • Scalability: The Company is able to take on large projects and has the capacity to expand, as a big company. * Expertise: The deep knowledge of aircraft systems and the manufacturing process can act as a competitive advantage for the company.

In-Depth Financial Analysis

The financial health of Spirit AeroSystems is complex and requires a thorough understanding.

  • Liquidity:
    • As of March 31, 2024, Spirit had a cash and cash equivalents position of $475 million. This is a bit low compared to the $1 billion in cash that the company had in 2021. The company had to make $345 million in cash interest payments in 2023, thus there is a risk that they will be in trouble if they do not manage to reduce its debt. -The company’s current ratio of 1.4 reflects its ability to meet short term obligations.
  • Solvency:
    • Spirit has a debt to equity ratio of ~1.4 and it has a leverage of more than 4 times, these levels are considered high, but might be justified by the long term nature of their contracts with Boeing and Airbus. However, if there is some external shock to the market, their solvency will be quickly tested.
  • Net-debt is ~$3.7 billion as of December 2022 and ~$4.0 billion as of December 2023, showing a continuous increase over time, putting the financials in a precarious position.
  • As of the 3 months ended December 31 2022, the company’s interest expense stood at $115.9m, while in the 3 months ended Dec 31 2021 it was $40.7m, thus there is an increased burden of the debt in their performance. Also, because the debt is mostly on variable rates, the interest expense will increase even further.
  • Profitability:
    • Spirit has been improving its revenues, however, it hasn’t reflected to their profits. The company has reported net losses in recent years, showing the problems with controlling their production cost. Their income is extremely dependent on the volume of production of their clients.
    • In 2023, the company generated total revenue of $5.2 billion against a net loss of $760.7m. This highlights the lack of profitability for the company.
    • Gross margins are not stable and depend heavily on contracts and efficiency of supply chain. They are often highly variable.
    • During the last years, the company has been facing issues related to the Boeing 737 Max production halt, the Russian invasion of Ukraine and the COVID-19 pandemic.
  • Cash Flow:
  • While operating cash flow appears to be positive, the company has negative free cash flow as they need to continually increase the capital expenditure for expansion of facilities and to produce higher volume of products. This also includes problems in its supply chain and production. The cash flows are too little to make debt repayment, which means new capital raising might be necessary for the company. - During 2023, the cash used in investment activities was around $370 million, which is a significant number and highlights the importance of capital expenditure for the business.

Spirit needs to focus more on profitability rather than growth. The company can grow by implementing technology and using economies of scale to lower production costs. It must also find a good balance between supply and production of products to avoid inventory issues.

Recent Concerns and Problems

Spirit has been facing numerous challenges including:

  • Supply Chain Issues and Production Issues: Recent supply chain problems have created a challenge to the company. These issues, and quality concerns in manufacturing, have resulted in production delays and increased cost. They have not been able to meet their customers expectation.
  • Debt Level: The high levels of debt is a great concern for the company’s financial stability and can become even harder to manage when interest rate are higher. They have not been able to lower this level of debt.
  • Profitability: The company has been struggling with profitability since long periods, and hasn’t been able to consistently improve it.
  • Cost Management: They are failing to manage costs and need improvement to maintain profitability and deliver consistent earnings.
  • Aerojet Contract: The company is in litigation with Aerojet which can have an impact to their profitability. The current state of the contract negotiations is also a major uncertainty for future cash flow projections.
  • Dependence on Boeing: The company is still overly dependent on Boeing, meaning any production or contract issues on Boeing will severely affect SPRs financials.
  • Internal Controls: The company has identified material weaknesses in internal controls, which raises a concern on the quality of its financial reporting and its ability to prevent fraud or errors.

Management’s Response

Management has been acknowledging these challenges and is trying to respond to them. It is currently focused on stabilizing the production line, fixing its supply chain, improving quality and profitability, and reducing the debt. However, it’s too early to say if they will be able to achieve these goals, but they seem to be pushing in the right direction.

  • They have outlined plans to improve its efficiency, quality controls, and supply chains, and implement continuous improvement tools.
  • They are focused on maintaining stable pricing and minimizing cost, in order to improve margins.
  • They are focused on improving their balance sheets by raising new equity and reducing debt.

Understandability: 3 / 5

While the core business of manufacturing aircraft parts is relatively easy to understand, analyzing the financials and prospects is a bit complex.

  • The company operates in a complex industry with many intricate contracts, supply chain dynamics, regulations, and long term partnerships with only a few clients.
  • The high level of debt and frequent reporting issues require a more detailed financial analysis.
  • The different segments of the company add some level of complexity to evaluating their performance.

Balance Sheet Health: 2 / 5

Spirit’s balance sheet reflects a concerning level of financial risk due to high debt levels and inconsistent profitability.

  • High debt burden is a problem for the company as it leads to higher interest expense and can cause liquidity issues when there are other issues in the business.
  • Negative free cash flow for the last couple of years shows that the company does not have the capability to generate sufficient cash to fund its activities, which might lead to more debt in the future or share dilution.
    • Non Recurring charges and other liabilities There have been certain non recurring charges and liability creation in the recent times that can impact their profitability and valuation. These items should be investigated thoroughly by any investors.
    • Low cash position means they do not have sufficient funds in order to pay short term debts and expenses.
  • Working Capital Management: The company is not managing its inventory well, thus has a high working capital requirement.

The high debt burden, poor cash flow, and low profitability paint a picture of financial health that warrants caution. Further, the recent issues with accounting and supply chain management also raise red flags to investors.

Additional Notes

Based on the latest earning calls, the company needs to prioritize growth to reduce debt. While having large contracts with Airbus and Boeing provides certain stability, it also means the company has no pricing power, and profitability is driven by its clients decisions. All the risks are related to the long term future of the business, and a lot must go right before the business can be properly considered as a good long term investment.