Wesco Aircraft (WAIR +0.00%) has found it difficult to compete against archrival KLX (KLXI +0.00%) in recent years, suspending guidance last year and then reporting an unexpected full-fiscal-year loss. Wesco has been mounting a comeback lately, but the company's challenges are set to intensify after Boeing (BA 3.55%) announced plans to buy KLX for $4.25 billion.
KLX and Wesco are both focused on distributing fasteners, consumables, and related products to the aerospace sector, acting as supply chain managers for parts. It is a business where scale is important, as larger companies tend to offer a more complete catalog of available parts and have the more expansive distribution network able to deliver a needed part to a customer faster.
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KLX, which was spun out of airplane-seat maker B/E Aerospace in December 2014, seemingly had the upper hand on Wesco. The company boasts more than 1 million part numbers in stock, compared to Wesco's 565,000 active SKUs, and last year claimed it had booked about $625 million in new business since the beginning of 2016 attributable to market-share gains.
"The differential performance between ourselves and the No. 2 competitor in the industry is pretty stark," KLX CEO Amin Khoury said on a conference call last summer.
Mixed news for Wesco
Boeing's acquisition of KLX in theory could help Wesco close that gap, if only because Boeing's airline customers and major suppliers are becoming increasingly concerned about the aerospace giant's market dominance. United Technologies last year announced plans to buy Rockwell Collins specifically to gain leverage against Boeing by building a more prominent position in Boeing's overall supply chain.
For years, Boeing has been focused on new plane sales, leaving much of the maintenance and spare parts business for suppliers. With Boeing pressuring suppliers to bring down costs on components to help it win an ongoing price war against Airbus (EADSY 0.57%) to sell new jets, suppliers have increasingly relied on the aftermarket to pad their profitability.
The deal for KLX continues Boeing's push into the aftermarket, toward CEO Dennis Muilenburg's goal to triple sales generated by the company's services arm to $50 billion over the next decade. One way for suppliers and customers to push back on Boeing would be to send more business Wesco's way.
But that optimism should be tempered by what a massive distribution presence Boeing is building, and the power that comes with that presence. Boeing is already one of the largest buyers of the fasteners, bolts, and seals that companies like KLX and Wesco distribute, and since 2012 has had an arrangement with parts manufacturers including Arconic and Berkshire Hathaway-owned Precision Castparts to buy parts at bulk pricing.
That arrangement also included purchases made by select Boeing subcontractors, and Boeing will likely try to apply it to KLX as well. If so, it would allow KLX to lower its overall procurement parts, and either undercut distribution competitors or boost its profitability.
KLX already has more global locations than Wesco, and Boeing, via its service contracts with aircraft customers, could broaden that aftermarket reach further. Similarly, Boeing will likely push suppliers on its defense side to work with KLX instead of other distributors as part of its maintenance and support programs. Wesco currently generates about 44% of sales from the military, so any shift there would be a blow to the company.
What becomes of Wesco?
KLX vs. Wesco was already beginning to feel like a mismatch prior to the Boeing deal. With Boeing's resources soon to be backing KLX, Wesco has a real uphill battle on its hands.
Wesco shares are cheap, trading at 0.64 times sales and a forward price-to-earnings ratio of 10.11, compared to 2.06 times sales and 14.05 times forward earnings for KLX. But it is only a bargain if suppliers and customers really do end up shifting business Wesco's way as a counter to Boeing's heft.
I'm skeptical that that will happen. Until there is some evidence to the contrary, Wesco shares should be avoided.
