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Spirit AeroSystems Still Has a Lot of Work to Do

By Lou Whiteman - Updated Aug 9, 2018 at 8:41AM

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The aerospace component supplier has struggled to get parts to Boeing and other customers on time. Production rates are up, but at a cost.

Spirit AeroSystems (SPR 6.28%) in recent quarters has struggled to keep up with soaring demand for Boeing and Airbus planes, leading to share price turbulence. The good news contained within the company's second-quarter results is that Spirit is finally beginning to catch up with that demand. The bad news is the expenses associated with that ramp.

Spirit posted adjusted earnings per share of $1.63 for the quarter, beating the $1.52 consensus estimate. However, the company's profitability came in below expectations. The company, a supplier of airplane fuselages and other components, at times during the quarter was forced to employ "surge resources" and pay for expedited shipping on massive Antonov freighter aircraft to keep its customers' final assembly lines running.

Boeing 737 MAX on assembly line.

A Boeing 737 MAX fuselage on the final assembly line. Image source: Boeing.

Overall gross margin, at about 14.4%, was up from 13% in the first quarter but still well below the 18% range that Wall Street expects in the second half.

With demand for narrow-body aircraft like Boeing's 737 showing no signs of subsiding, Spirit figures to have a steady stream of orders coming in for the next few years. The question becomes whether the company can bring down costs enough to really benefit from that strong book of business.

Delays on the line

Boeing, which until 2005 owned Spirit outright and remains its most important customer, put pressure on its entire supply chain last year when it announced plans to increase 737 production from 47 frames per month to 52. Spirit and others have struggled to keep up, with The Seattle Times reporting last week that supply chain issues have led to a backup that at times has meant about 40 unfinished 737s squeezed into spaces around Boeing's Renton, Wash., final assembly plant.

Spirit CEO Thomas C. Gentile, on a call with investors following the earnings release, said that although 737 fuselage deliveries have increased, there continue to be issues. Spirit delivers to Boeing from its plant in Wichita nightly, but Gentile said there have been "some instances where we find some quality issues right at the end" that cause delays. Those issues can lead to fuselages being delivered out of order, which causes additional stress on the Boeing production line because components added to the fuselage vary by customer and by specific model.

When issues emerge, Spirit is often forced to spend extra on expedited shipping to keep Boeing happy.

Gentile said he expects the problems to be "reduced substantially" in the second half, saying, "We're extremely confident that we're going to make all the deliveries" for the year. But the stress on the line figures not to let up. Boeing is planning another 737 rate increase in 2019, going to 57 frames per month.

Merger on track

Spirit, though no longer part of Boeing, still generates more than two-thirds of sales from its former parent. The company is attempting to diversify, adding work on Airbus jets, the F-35 fighter, and other military aircraft. It took a big step in that direction in May when it agreed to acquire Asco Industries.

Asco, by comparison, gets about half of its sales from Airbus and an additional 30% from other non-Boeing customers. The target has at least some excess capacity at each of its four facilities, and Spirit has said it intends to act quickly once the deal closes to fill that capacity and hopefully take some of the stress off its existing operation.

Gentile said that the deal is on track to close before year's end, saying, "we remain excited regarding the Asco acquisition as a compelling strategic and operational fit which will enable Spirit to accelerate our growth with Airbus, expand our military sales, grow our fabrication business, and strengthen our supply chain to support our execution on all programs."

The deal right now is putting extra pressure on Spirit's results, with the company reporting $0.32 per share in Asco-related costs including transition expenses and interest on the $650 million it is borrowing to execute that transaction. That debt should be manageable, with Spirit predicting full-year adjusted free cash flow of between $550 million and $600 million in 2018 and a similar performance likely in 2019.

Slow progress

Spirit's quarterly update provided a reminder of all the issues the company is facing and at least a hint that the worst of its operational issues might finally be behind it. Gentile and his team seem cognizant of the fuselage supply constraints and how to solve them, but Boeing is constantly upping the pressure on Spirit and other suppliers. Add in the upcoming integration of Asco, and there are a lot of moving parts at Spirit right now.

For those with a high tolerance for risk, it could be a good time to buy into Spirit. The company isn't cheap, trading at about 18 times trailing earnings, but if it is able to eliminate surge costs in the quarters to come and successfully integrate Asco, overall profitability should improve.

Spirit's history as an independent has been full of both promise and disappointment, and I'm not yet ready to declare with any certainty that this time they'll get it right. But there's great potential in this company. I'll be watching closely in the quarters to come, looking for a reason to buy in.


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