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Morningstar | Practice Like You Play: Spirit Preparing to Avoid Production Snafus in 2019

Despite facing difficulties on its flagship 737 program in 2018, no-moat Spirit Aerosystems reported out decent fourth-quarter and full-year results. More importantly, management issued 2019 guidance ahead of consensus. Although guidance excludes its pending acquisition of Asco, we incorporate the deal into our model starting mid-2019. We also view the new Boeing agreement, which provides visibility through 2030, as a positive. Given the 2019 guide, we plan to raise our fair value estimate of $88 per share but not significantly (about 3%) since we aren't moving up our midcycle assumptions.

Revenue guidance for 2019 implies 12.5% year-over-year growth, with 737 and 787 rate step-ups driving the top line . Management continues to believe it will reach 16.5% segment margins in 2019. Spirit believes this represents the normalized margins its operating units should achieve, collectively. This translates into an adjusted EPS guide of $7.35-$7.60 (about 19% growth at the midpoint). Adjusted free cash flow guidance for 2019 didn't impress as much and came in basically flat as a percentage of sales compared with the prior year. But it should grow around $85 million, reaching $650 million this year.

Spirit is preparing for a production rate of 57 per month on the 737 (it is currently at 52) and we think this will likely happen around midyear. To achieve a smooth rate break, Spirit is conducting rehearsals that simulate shipment of three 737 units daily. The company is also prepping suppliers, bringing some work in-house, hiring more aggressively in advance, and restructuring its assembly lines by moving to three lines from two plus building surge capacity.

The new Boeing agreement covers all programs through 2030 and the 787 up to line unit 2,205. According to management, the 787's price will go above cost after line unit 1,405, which will probably be reached sometime in 2022.

Boeing also agreed to suspend Spirit's advance repayments until line unit 1,135 is reached and then restate them at a lower rate of $450,000 per aircraft through line unit 1,605. This implies that repayments won't restart until late 2020. The negotiations with Boeing didn't include the next-generation midsize aircraft. Unlike the engine manufacturers, which we hear Boeing has already solicited bids from, it doesn't appear that Boeing has put out formal requests to aerostructure suppliers on the NMA.

On the 787, Spirit is already stepping up to 14 aircraft per month from 12. Defense work should also contribute a bit to growth and after increasing 20% in 2018, Spirit is anticipating defense activities to grow 15% in 2019 to about $600 million in revenue. Fuselage work on the CH-53K helicopter for Lockheed and B21 bomber work for Northrop Grumman--the program is classified but we think Spirit may be working on the wings or other large structures--are driving defense sales.

Turning back to the fourth-quarter and full-year numbers, 2018 revenue grew 3%--right in line with management guidance at the start of 2018. Operating margins stepped up 60 basis points in the quarter and rose 410 basis points over 2018 thanks to higher production of the 737, the ASC 606 accounting change improving A350 margins, and the absence of 787 charges this year. Adjusted EPS rose 40% in the quarter and 17% for the full year, landing at $6.26. Adjusted free cash flow stood at $565 million during 2018, which is in the middle of management's targeted range of 7%-9% free cash flow as a percentage of sales.

Shipset deliveries hit 1,734, up from 1,651 in 2017. Deliveries to Boeing grew due to higher deliveries on the 737, partially offset by lower 777 deliveries as Boeing and Spirit transition to the 777X. We expect 737 deliveries to continue increasing in 2019 thanks to the MAX ramp; MAX variants should represent about 90% of shipsets in 2019. Shipsets bound for Airbus increased to 835 versus 791 in 2017 thanks to A350 and A320 deliveries ramping up but the A330 saw a stepdown in rates.