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Morningstar | 737 Costs Weigh on Spirit Aerosystems' Results; 2nd-Half Performance Critical

Spirit Aerosystems is successfully recovering 737 deliveries--the company fell behind by about a dozen shipsets earlier this year--but it's incurring higher costs to meet its targets. Management will need to ramp operating margins over the back half of the year, focusing on the fuselage segment (where significant 737 content sits) to hit full-year adjusted EPS guidance, which was unchanged at $6.25-$6.50. We believe Spirit can deliver operating margin expansion at fuselage systems versus the first half of this year, but bringing down 737 costs does present a challenge (roughly 300 basis points of sequential improvement is required in the fuselage unit). Management looks on track to close the Asco Industries acquisition later this year, with most of Asco being folded into wing systems. Since we don’t envision any roadblocks to the deal, we’re including it in our valuation. We did trim our 2018 forecast slightly to reflect 737 risks, but this didn’t affect our $87 fair value estimate materially, which we’re increasing by $1 due to the time value of money. Shares look fully valued at a price/fair value ratio close to 1.0.

Year-over-year revenue comparisons are skewed by the ASC 606 adoption, which resulted in lower revenue recognition this year on the 787 and A350. Looking through the accounting, Spirit delivered a record number of shipsets this quarter thanks to the 737 program--169 versus 136 last year and 128 in the first quarter of 2018. A charge during the second quarter of 2017 connected to the new agreement with Boeing and related 787 forward losses caused GAAP operating margins to soar year over year to 11.8% compared with negative 5% in 2017. Controlling for program charges and some smaller items, the propulsion and fuselage businesses registered margin contraction and at the latter, margins dropped 280 basis points. Normalized operating margins for Spirit contracted about 200 basis points to 14.7%. Adjusted EPS rose 6 cents to $1.63 this quarter.

Adjusted free cash flow landed at $171 million, or 9.3% of revenue, which is just above management’s unchanged objective of 7%-9%. Management also announced that the company had initiated an accelerated share repurchase program of $725 million.