Description

Brief Description: -

Wesco Aircraft seems to have limited downside around current levels. It also has growth opportunities that seem to be achievable and imply an upside of 75+% over the next 3-4 years.

Wesco Aircraft is one of the largest distributors catering to the aerospace industry. A previous VIC writeup provides a pretty good description of the business and its history, which I will not duplicate here. Since that time, Wesco has acquired (Feb’ 2014) Haas, a Chemical supply chain management services company. Today the business mix consists of 49% hardware, 40% chemicals and 7% electronic components.

This picture from their latest 10K provides a good overview of their sales mix -

Industry/Business Model: -

WAIR’s main competitors (in hardware) are KLX Inc. (recently spun off from BEAV, competes with WAIR through its ASG segment), Patton Air and Align Aerospace. The market for products supplied by distributors such as WAIR is approximately $4.7 billion (Actually totally about $7 billion, â…“ of which is supplied by manufacturers themselves - like PCP, Alcoa). WAIR (at := 19.4%) and KLX Inc.’s ASG segment (:= 28%) are the share leaders. This can also be seen in the SKUs sold by each the leaders - KLX - 1 million; WAIR - 575k; Patton Air - 200k and Align Aerospace - 100k

Like most distributors, WAIR and KLX provide a strong value proposition in the form of cost savings in procurement (ability to aggregate purchasing of different SKUs for multiple OEMs) and inventory warehousing (reduction in working capital for OEMs). In addition Wesco Aircraft is pretty much integrated into the OEM’s supply chains which drives further labor/cost savings for them. The portion of the industry directly supplied by manufacturers (like PCP and Alcoa) are really higher volume SKUs that makes it feasible for them to supply directly.

These are the ROIs of WAIR, and KLX. WAIR’s post 2013 are not really comparable because of the acquisition of Haas (in Feb 2014).

WAIR: -

                                                                                                     2013 2012           2011            2010 2009

KLX: -

WAIR also seems to score higher in working capital management, having a CCC in the 400-450 day range versus KLX (->ASG) in the low 500 range.

It appears that Wesco aircraft has the stronger distribution business. KLX seems to be intent on entering the energy services space (a segment which makes up 22% of its revenues - which KLX started by acquiring companies in late 2013 and 2014, arguably bad timing, as the sector was getting demolished), and an investor in KLX is also taking on the additional risk of management mis-executing the energy services entry. However, cnm3d’s KLX writeup is a good counterpoint to this assertion.

WAIR’s strategy has been to move its customers to more long-term contracts. Although, such contracts have lower margins than Ad-Hoc contracts, they are more predictable. Today 74% of sales are derived from long-term contracts. Note that Haas (a Chemical distributor) was acquired in 2014. Prior to that, about 60% of legacy WAIR sales were long term. The Haas business operated with about 95% of its sales under long-term contracts, that’s why we see the updated long-term contract number.

Long-term contracts are usually 3-5 years in length. WAIR’s customer retention rate is very high, well north of 90% - which serves to illustrate the sticky nature of its relationships. Wesco’s hardware business has really grown on the OE side and they do not have much exposure to the MRO side (which is about 7% of sales or about $100 million). The type of business is really an ad-hoc business and Wesco is just starting to put additional resources in this area. With a total size of $1-$2 billion, it represents a growth opportunity for them.

Haas (Chemicals) is a lower margin business and is more complicated, requiring specialized knowledge of managing inventory with a finite shelf life and extensive regulatory requirements. Though the risk profile of the business has changed somewhat, WAIR should be able to manage it. The market that Haas serves is about $4 billion in size. There are also a lot of customers that are in common between WAIR and Haas so this should provide for more cross selling opportunities (for example, the recent contract extension with Triumph which includes both Hardware and Chemicals). WAIR shares about 30 of their largest customers between chemicals and hardware.

WAIR’s business model is very asset light, with capex as a % of revenue of only 0.64% and < 5% of adjusted EBITDA. While they took on debt for the Haas acquisition (it is currently at 4x Debt/EBITDA), management has guided to a 3x ratio over the next two years. It seems manageable with interest expense < 20% of adjusted EBITDA and half maturities in 2018 and the rest after 2020. Almost 80% of FCF gets converted to Net Income (using 5 year average values ending FY 2014).

Key Issues: -

1) Wesco is well positioned to take advantage of the expected build rates in commercial aircraft. The demand drivers for this are - an increasing and increasingly wealthier world population, increasing globalization which leads to an increased need for business as well as leisure travel. Both Boeing and Airbus are reporting massive backlogs in orders which should bode well for the aircraft supply industry.

2) Disintermediation by Boeing: -  This has been addressed in previous writeups on VIC about this industry (WAIR, KLXI). BASN was not really a way for Boeing to disintermediate suppliers. Basically, in 2007-2008, lead times for fasteners stretched to 2 years and Boeing started BASN to purchase fasteners directly. It mostly affects their tier 1 and tier 2 suppliers. According to IR, though they did see some pressure from this initiative, they have not seen incremental pressure lately. The proportion of Class-C hardware supplied by distributors like KLX and WAIR has not changed much the past few years. Boeing also represents < 10% of sales (I verified this number again with IR).

3) Wesco aircraft is undergoing an aggressive cost structure reduction effort - of sites as well as sg&a. They have guided to a $25-$30 million improvement from these efforts which seem achievable.

4) Wesco’s acquisition of Haas doubled their revenues from $776 million in FY 2012 to $1.5 billion in FY 2015. They seem to be having integration issues from this acquisition which management has addressed on the call. It is tough to surmise that all is hunky dory but I like that they are addressing them - especially the cultural differences. This is definitely something to be watched but I believe it is fixable and they seem to be moving in the right direction (ref: recent Chemicals+Hardware win with Triumph).

Valuation: -

If I use adjusted FY 2015 EBITDA and the low end of the cost saving improvement targets, FY 2015 adjusted EBITDA is about $217 million. A 10x multiple (other distributors trade at higher multiples - like FAST: 15x, GWW: 10.62, MSM: 11x - I haven’t used KLX because 23% of their sales come from energy services), it implies a stock price around $13.8 (-4% from the current stock price). Other comps are also higher - BEAV bought UFC Aerospace at about 11x EBITDA before spinning off KLX. Obviously the stock was much cheaper in the $11 range a short while back - but downside from these levels appears low. Current FCF (reported) yield, of about 9.4% is cheap for this stock and should provide a floor.

The business is capex light and does not require a lot of capital to grow. Growth in OE deliveries over the next 15 years are expected to be about 3.9%. Wesco has guided to a high single digit growth in sales. That should be achievable given the cross selling opportunities between Hardware and Chemicals. If I expect EBITDA to grow at a conservative 7% over the next few years, in three years, a 10x multiple implies a $17 stock price (or 18.2% upside). The stock might also potentially rerate to 11x or higher - based upon debt paydown as well as resolution of the integration issues between Haas and legacy Wesco. A 11x multiple implies 40% upside). A 12x -  53% upside.

There is also substantial growth opportunity in MRO sales - which make up only $100 million odd of Wesco’s sales (out of a total market of $1 -$2 billion). These sales are ad-hoc so they have a higher margin (contracted sales are lower margin). KLX seems to be getting 23% operating margin from their aftermarket business (which is about $525 million currently) vs 15% for the rest - or an almost 8% differential. If we assume that WAIR gets 21% EBIT margins on their future MRO business, which they are able to grow, the next $100 million is at a $21 million of incremental EBIT and implies a $25 stock price (or 74% upside).

Catalysts: -

1. Growth of their traditional business

2. Executing on MRO sales opportunity

3. Integration of Haas and Wesco leading to additional cross-selling/growth opportunities

Risks: -

1. Downturn in the aerospace OEM market

2. Boeing disintermediation is still a risk and needs to be watched

3. Execution issues integrating a big acquisition

4. Haas’s two major suppliers - PPG and Henkel might create competitive issues by trying to supply directly. Haas has grown despite this - so this risk seems to be mitigated.

Catalyst

1. Growth of their traditional business

2. Executing on MRO sales opportunity

3. Integration of Haas and Wesco leading to additional cross-selling/growth opportunities