Description

AstroNova (NASDAQ: “ALOT”) was founded ~50 years ago, originally providing test and measurement products used by NASA in rocket telemetry. Through internal innovation and numerous acquisitions, AstroNova has expanded beyond this legacy business. Today, AstroNova’s primary operations are in aerospace parts and supplies (cockpit printers, Ethernet switches, and related consumables) as well as digital label printing.  AstroNova had LTM April 2021 revenue and EBITDA of $114m and $11m, respectively. The company currently has a market capitalization and enterprise value of ~$100m. The stock is relatively illiquid (~$300k per day) so this idea may be more suitable for the PA.

AstroNova trades at 9.1x LTM EBITDA and 11.9x LTM EBITDA-CapEx, which I view as attractive relative to other aerospace parts suppliers which trade between 14x-25x 2021e EBITDA. Furthermore, AstroNova’s LTM earnings are depressed due to the pandemic and issues related to the Boeing 737 MAX. Aerospace suppliers trade at premium multiples as they are inherently attractive businesses with high barriers to entry and significant aftermarket exposure (greater predictability). I estimate the majority of AstroNova’s value resides in its aerospace business, a segment whose value is not being fully reflected in the company’s current stock price. Additionally, this division will serve as a platform from which to acquire additional niche aerospace businesses, a strategy the company is actively formulating. AstroNova also benefits from a highly recurring revenue base (~70%), stemming from the ongoing sale of repairs and spare parts, as well as other consumables such as paper and ink. 

In addition to the obvious headwinds caused by the pandemic, the grounding of the Boeing 737 MAX (a key and highly profitable program) has temporarily slowed printer sales tied to new 737 MAX aircraft. The 737 MAX shutdown has also forced airlines to maximize the utilization of their remaining fleets, which has significantly hampered AstroNova’s retrofitting opportunity across the entire installed base (more below). AstroNova is further burdened by certain start-up and non-recurring costs flowing through the P&L that will ultimately be absorbed or rolled-off.  On a normalized, “earnings power” basis, I estimate AstroNova trades at 6.3x EBITDA. For my earnings power definition, I start with LTM EBITDA and add 2 components: (i) the expected contribution from the resumption of 737 MAX builds (per Boeing’s FY 2022 guidance) and (ii) the expected annualized contribution of the long-tailed retrofit opportunity across the existing commercial fleet. Notably, I’m not incorporating any contribution from the ongoing recovery in air travel and new plane deliveries.

SUMMARY HISTORICAL FINANCIALS

BUSINESS OVERVIEW

AstroNova operates in two business segments: Test & Measurement and Product Identification. 

Test & Measurement – 18% of EBITDA pre corporate OH (67% pre-COVID)

The T&M segment is further broken down into two businesses, “Aerospace” and “Test & Measurement”:

Aerospace: This sub-segment sells ruggedized cockpit printers for commercial and military aircraft, as well as business jets. Cockpit printers are used to print critical materials including identified flight paths, maps, clearance information, weather reports and other air traffic control data. These materials can be printed before take-off or in-flight, depending on the nature of the content (i.e., flight paths versus real-time updates). AstroNova’s printers, on average, cost $10k-$20k each, depending on the underlying aircraft type and the go-to-market model (sold directly to the airlines or to a supplier). AstroNova assembled this business via three key acquisitions including Miltope in 2014, RITEC in 2016 and Honeywell’s cockpit printer business in 2018. AstroNova now has virtually 100% share of cockpit printers within the commercial aerospace industry. Due to the small size of the assets acquired, AstroNova was not subject to “HSR” rules and essentially built a monopoly-like position without any anti-trust review.

A much smaller component of the T&M segment includes Ethernet switches which are used to enable internet connectivity on both military and commercial aircraft. There are only a handful of available providers for these products.

Test & Measurement: This sub-segment sells hardware and systems used to acquire, record, process and analyze data in various processes including R&D, field testing, production and maintenance. Key industries served include aerospace and defense, energy, transportation, automotive and leisure facilities such as amusement parks.

While the company does not currently provide sub-segment reporting, I estimate the vast majority of profitability in the T&M segment stems from the aerospace business.

Product Identification/“PI” (82% of EBITDA pre corporate OH (historically 33% pre-COVID)

The PI segment sells a suite of tabletop and large-format digital color label printers as well as the attendant consumables such as labels and ink. AstroNova’s printers enable customers to print labels on-demand on a short-run (limited quantity) basis. To give context to their scope, AstroNova’s printers print 1 foot of material and 7m dots per second and cost upwards of $10k per unit.

AstroNova’s products primarily serve small, independent business customers. However, a recent acquisition (TrojanLabel) has increased their exposure to larger, more established companies. Key verticals served include food and beverage, cosmetics, medical and pharmaceuticals.

For certain verticals with more stringent safety requirements such as food & beverage and pharmaceutical, AstroNova relies on its materials science know-how to measure and embed properties such as moisture, chemical solvent and UV light resistance within its labels. These technical aspects add a degree of complexity to the label manufacturing process and somewhat limit the threat of new entrants to the industry.

The primary competition to this business is the outsourced commercial printer. Traditionally, customers would order labels from these commercial printers, which would introduce wait times as well as potential waste from over-ordering. AstroNova’s printers eliminate these issues by offering flexibility (ability to print on-premise in real-time) and improved efficiencies (print only what you need, on-demand). Given these underlying benefits, the digital printing industry has taken share from traditional commercial printers in recent years.

AstroNova’s printers are attached to proprietary software that drives the various printing templates customers may use and helps configure important settings such as color matching, etc. Familiarity and dependency on this underlying software creates a degree of stickiness within AstroNova’s customer base. The software also serves as a comprehensive file management system of all created labels and designs, which adds to the stickiness over time. Additionally, the PI business generates significant recurring revenue in the form of replacement labels and ink. The attach rate of consumables in this segment approaches 95%. Taken together, the software, labels and ink create a closed-loop system that acts as a moat around the PI business.

Based on company estimates, AstroNova has ~25% of the onsite digital label printing business.

GROWTH DRIVERS

Test & Measurement

One of the primary growth drivers for the T&M segment is the rate of new airplane deliveries. Prior to the pandemic, new plane deliveries were expected to grow at a mid-single-digit % rate over the intermediate term. While the outlook for new deliveries may be murky emerging out of the pandemic, it is plausible that deliveries return to the historical rate of growth over time. With AstroNova’s printers and Ethernet switches present on the vast majority of new planes, the company should benefit commensurately.

Another source of growth is retrofitting, or replacing older versions of printers with newer models. AstroNova’s newest line of printers offer many enhancements including lighter weight (greater fuel efficiency), better resolution, faster print speed and more memory. Another motivation to upgrade is that airlines typically prefer to harmonize and simplify their supply chain. As newer planes enter their fleet, airlines will retrofit older models to have uniform components. This is done in order to better manage inventory levels and the overall maintenance process (i.e., technicians require familiarity with a narrower range of parts). Retrofits typically take place either in conjunction with routine or optional maintenance, on a fairly discretionary basis. My preliminary understanding is that the average age of the planes in AstroNova’s installed base is 7 years versus an average life span of ~10 years for the underlying printers.

Based on preliminary analysis, I believe the potential retrofit opportunity could be large as ~$100m in revenue and ~$40m in EBITDA. While this business will be phased in over the next 15-20 years, the retrofit opportunity could provide a significant boost to T&M segment results. For context, pre-pandemic, the T&M segment generated ~$50m in revenue and ~$15m in EBITDA (pre-corporate).

The retrofit opportunity has not been captured previously because the upgraded printer currently being marketed was designed by AstroNova, not one of the three legacy manufacturers it acquired. Despite its superior features, AstroNova struggled to break into the cockpit printer industry due to a lack of relationships and the huge barriers to entry surrounding the FAA certification process (more below). A key motivation for AstroNova’s acquisition of the Honeywell cockpit printer business in particular was to position itself to capture the lucrative retrofit opportunity outlined above. The Honeywell business provided inroads to the two largest single aisle aircraft, the Boeing 737 and the Airbus A320, which make up ~60% of commercial airplane shipments. While AstroNova (via its Honeywell acquisition) sells directly to Airbus (its printers come standard on all A320’s), the go-to-market strategy for Boeing involves selling directly to the airlines. With these direct selling relationships now established, AstroNova is now equipped to pursue the retrofit opportunity in earnest. In addition, selling directly to airlines represents a much higher margin sale. I estimate the EBITDA margins on the Boeing sales are in the 40%-50% range versus ~30% for the Airbus business.

The reason for the wide margin differential between the Boeing and Airbus businesses is that the go-to-market selling model is different. For Airbus, AstroNova sells direct to Airbus. The benefit is that printers are standard across all Airbus 320’s, the popular narrowbody plane. Any airline that orders an A320 automatically has a printer installed on it. The disadvantage is AstroNova is selling directly to Airbus and hence receives a lower selling price. For Boeing, the printer is categorized as “BFE” (buyer furnished equipment), meaning that the printer is listed as an option and the individual airlines decide whether to include it. Because AstroNova is selling to individual airlines, however, the selling price for the printer is markedly different (i.e., higher). This is part of the opportunity for the company. The Honeywell acquisition essentially gave AstroNova the Boeing narrowbody (737) exposure for the first time. In their FY 2019, investors got a glimpse of the massive operating leverage for a few quarters before the MAX issues surfaced. Selling direct to the airlines also opens AstroNova up to the retrofit opportunity because that is an individual airline decision. 

The third source of growth is aftermarket. Two excellent proxies for aftermarket growth are Revenue Passenger Miles (“RPM”) and Available Seat Miles (or “ASM”), which both measure the utilization of existing aircraft. These metrics have consistently increased over many years due to the growing nature of global air travel. Over the past 15 years (pre-pandemic), RPM and ASM have grown at a ~4% and ~3% CAGR, respectively, while in recent years, the growth rates have been higher, at ~5%. These measures serve as helpful indicators for the growth in AstroNova’s recurring aftermarket revenue streams such as ongoing printer repairs, spare parts and paper as air travel continues to recover.

Product Identification

The PI segment has experienced low to mid-single-digit % organic revenue growth in recent years due to the proliferation of smaller, “upstart” companies, particularly in the food & beverage and other consumer markets. Remarkably, the business grew 2% in their fiscal year ended Jan 2021, right in the midst of the pandemic. The driving force behind the proliferation of upstarts has been evolving consumer choice (desire for more authentic/local/custom products) as well as ease with which new brands can be created today relative to the past (low-cost social media based advertising, availability of contract manufacturers, expanded distribution options). These smaller companies typically require the ability to perform on-demand, short run printing as they manage fluctuations in their business. Digital printers are well suited to meet these needs, which has underpinned growth within the PI segment.

KEY THESIS POINTS

Aerospace Parts: A High Quality and High Barrier to Entry Business

Aerospace parts suppliers are inherently attractive businesses with significant high-margin aftermarket exposure and high barriers to entry that take numerous forms. 

First, every single part that goes onto an airplane - and any attendant consumable (such as printer paper) - must pass a rigorous and costly (up to $1m per part) FAA approval process. The spirit behind this process is to ensure the utmost safety of any plane flying in the air.

Second, once approved by the FAA, a supplier must enter into a design and qualification process to become specified onto each individual airplane program. This approval process typically concludes with a “sole source” position for the winning vendor. This is because the low overall value of most parts and the infrequent nature of purchases often results in a market that is too small for multiple parties to earn an adequate return on their R&D and marketing dollars, especially if they only capture a portion of the overall pie. Once approved, a part is “spec’d in” to a given airplane program for the entire life of the model. Any future replacement of that part, either due to routine maintenance, breakage or upgrade, must be replaced with either the same part or another FAA-certified part. For context, a typical airplane will be in production for 25-30 years and can remain in operation for a similar period of time. Therefore, aerospace suppliers can generate business off a single program for up to 50-60 years. This long-tailed opportunity includes the sale of original parts sales and lucrative aftermarket business that can equal or exceed what was generated from the initial product sale.

Lastly, as articulated above, the niche and low dollar value nature of many aerospace products results in limited competition. While there are companies (such as publicly-traded HEICO) whose business model entails reverse engineering airplane parts and attaining FAA approval, this is an expensive and time consuming process and one that is reserved for products with large TAMs, high turnover and high price points (such as brake pads and engine parts) that can justify the expense. In most cases, going through this process is simply not worth the effort. Given the small size of AstroNova’s markets in particular, I do not believe the return on time or capital is worthwhile for these participants. Similarly, attempting to convince aircraft OEMs and airlines to switch out of the original part to achieve moderate cost savings on a low dollar item is a difficult selling proposition. Consequently, AstroNova’s cockpit printers enjoy nil competition today, a position I expect to continue.

Sustainable “Printing” Assets

Based on my research thus far, I believe cockpit printers will retain their placement on airplanes for the foreseeable future. While cockpit printers are not required to be installed by the FAA, virtually every airline has nonetheless opted to include them on the majority of their fleet.

The main reason for the ubiquity of flight deck printers is they provide a valuable safety function at a relatively low cost. Having critical flight information and updates accessible at all times via printouts provides a valuable layer of redundancy in the event of a broader aircraft communications system failure. For a very small cost (~$10k-$20k per printer relative to total cost of $100m+ for a commercial airplane), airlines gain comfort with having an additional mode of reliable communication.

Additionally, ease of access to printed information acts as a helpful workflow management tool for pilots. Printouts obviate the need for pilots to thumb through various interfaces on the ACARS (Aircraft Communications Addressing and Reporting System) cockpit system or their iPad to find the information they are looking for. Searching for this information can be particularly cumbersome during times of turbulence. Further, the receipt of a clearly printed message to the cockpit spares pilots from having to take notes via voice communication, a process which can be distracting and result in instructions that are incomplete or difficult to decipher.

Printers also act as a liability management tool. In certain countries, physical flight records are required to be kept for up to 6 years, in which case a cockpit printer is a necessity. Regulators are interested in preventing “gross navigational errors”, or large deviations from a specific flight route. An inability to produce these records in the event of an audit could result in a substantial fine or the loss of one’s pilot’s license.

It is my understanding that pilots engaged in international flights are required to be proficient in English. For pilots less comfortable with speaking English, printouts (in English) that can instead be read are sometimes preferred and can serve as communications reinforcement. Additionally, an anecdote I heard is the co-pilot on international flights (who is typically younger and may have a deeper grasp of English) may jot down notations on the printouts to highlight or translate certain keywords for the pilot into their native language.

According to management, for flights going over a body of water, the presence of a cockpit printer grants airlines “advantaged route access” or access to preferred routes that can be up to 30 minutes shorter than what would otherwise be available. These routes are offered as an inducement for airlines to have communication redundancy in the aircraft, a key selling point of cockpit printers. While not all planes fly over water, airlines often will install printers throughout their fleets in order to maximize asset/route flexibility.

Lastly, increasingly crowded skies due to the growth of global travel have put a strain on air traffic control personnel and the physical radio frequency capacity. Providing quick updates such as clearance information or route changes directly to the cockpit printer rather than via voice or “squawk” can reduce drags on the system and generate efficiencies in areas such as takeoff time, etc.

My preliminary research findings were confirmed and expanded upon several conversation with both commercial and business jet pilots. Generally, they described the cockpit printer as a “nice to have”, “very useful”, “very convenient” and most noted they use it during every flight. The primary benefit they derive from printers is that they “reduce the work load” by allowing key documents to be available at their fingertips rather than having to toggle through the cockpit’s information system. These documents include clearance, weather and flight path information. Additionally, any route changes that are received mid-flight can easily be printed with the push of an onscreen button. Retaining a hard copy of clearance instructions for record keeping/liability management was also very important to the pilots.

The alternative to any of these use cases would be taking notes which unnecessarily consumes time and can introduce errors. Additionally, for record keeping purposes, hand-written notes are not as useful as they don’t contain the information exactly as it was displayed or delivered, which can cause data disputes in the case of an audit. The printer itself does not consume much real estate and the space that it does consume does not have an obvious better use.

Earnings Inflection / One-Time Costs

AstroNova has invested significantly throughout its business to capture future growth, further depressing current earnings.

Key areas of investment include:

1.      Standing up several new sales and technology centers (which act as showrooms for the PI segment), with a cost of several million dollars per year.

2.      Selling and administrative functions to support the newly acquired Honeywell business, which sells direct to airlines. This selling model is higher margin but entails many more touch points (selling directly to each individual airline versus selling to Airbus), necessitating additional resources and personnel.

3.      Redundant “tolling” or transition fees paid to Honeywell (~$500k on an annualized basis) that will subside once the business is fully transitioned later this year.

These investments have burdened segment performance and inflated overall corporate expense. The company is also in the late stages of implementing a new ERP system (capital cost of $2m-$3m, flowing through CapEx), that should enable the company to realize future operational and working capital benefits. In recent years, working capital investment has been a meaningful drag on free cash flow generation, particularly as the company builds inventory to support the Honeywell business.

AstroNova’s investment phase is now mostly complete. Going forward, the company should capture return on this spend and generate very high (~40%) incremental margins. According to the company, AstroNova is now in a position to double the size of the business without meaningful additional infrastructure investments. While this level of growth is not my expectation, it demonstrates the magnitude of upfront costs that have already been made by AstroNova. These investments will allow the company to continue to expand without a high degree of additional required spend.

High Degree of Recurring Revenue

AstroNova has a high degree of recurring or consumable revenue (70% of total) driven by the sale of spare parts and paper for its airborne printers and ink/labels for its digital printers. Overall recurring revenue is ~60% of sales with an additional 10% derived from routine service/maintenance revenue. These recurring revenue streams introduce a higher degree of predictability to AstroNova’s business. The balance of revenue is generated from hardware sales. Note, the recurring mix within the T&M segment currently skews much lower than the PI segment.

While alternate paper is available for AstroNova’s cockpit printers, customers will often purchase the “OEM” version to ensure reliable functioning of the underlying equipment. AstroNova has begun the process of refusing to repair printers if other third party paper was used in an effort to increase the consumables mix within T&M. Spare parts involved in printer repairs must be procured from AstroNova, meaning there are no other suppliers certified by the FAA for these parts. Within the PI segment, a razor/razor blade dynamic exists as 95% of digital label printer customers procure ink and labels through AstroNova.

Consolidation Opportunity

The aerospace parts industry presents a compelling area for consolidation given its inherently attractive attributes, relatively fragmented nature and the ability to gain additional pricing power via scale and wider product selection. Additionally, an acquisition strategy within the aerospace niche will allow AstroNova to expand its portfolio beyond its current singular focus on cockpit printers.

Based on discussions with management, it is clear they appreciate the merits of this strategy. In fact, AstroNova recently retained an aerospace industry consultant to map out the most attractive areas for potential acquisitions. The company intends to focus on low-cost, “non-flight essential” products that tie into the aircraft’s main communication systems, which I believe is a prudent course.

AstroNova has no net debt and should be a highly cash generative business, positioning it well to execute future acquisitions.  

Strong Management Team

AstroNova is led by a solid management team, particularly for a company of its size.

For most of its 50 year existence, AstroNova was a family/founder run business. This changed in 2014 when Greg Woods succeeded co-founder Everett Pizzuti as CEO of the company. Greg joined AstroNova in 2012 as COO and previously ran the electronics controls division at Danaher. Danaher is a highly-regarded industrial conglomerate renowned for its lean operations, value-enhancing M&A strategy and shareholder friendly orientation. Greg has been implementing elements of each of these strategies while at AstroNova, centered on a set of principles called the AstroNova Operating System (“AOS”). Notably, Greg is also trained as a commercial pilot, giving him added familiarity with the aerospace industry and its products.

AstroNova’s CFO, David Smith, was previously the CFO of several large public companies including Crane Co and Dover, and most recently spent a decade at a number of middle-market private-equity owned companies.

My interactions with Greg and David have been very positive thus far and have been impressed with their vision for the company.

Catalyst

737 Max deliveries continue to ramp

Company shows some success on retrofit awards