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Morningstar | Spirit AeroSystems Is Growing Thanks to the 737 Ramp and M&A

Spirit AeroSystems manufactures airplane parts such as fuselages, nacelles, and wings. It possesses expertise in traditional metallic manufacturing and assembly for programs like the Boeing 737, 747, and 767 as well as composites on the 787 and Airbus A350. The Wichita-based firm holds contracts with Boeing and Airbus. However, because of its legacy as an internal Boeing supplier (Spirit was spun off from Boeing in 2005), Boeing accounts for over 80% of revenue.Over the past several years, program challenges led to reduced profitability and depressed cash flows. Former CEO Larry Lawson focused on cutting costs and ensuring that Spirit was paid appropriately for its work. His efforts resulted in solid performance, resulting in double-digit margins versus negative margins when he took over. New CEO Tom Gentile, who hails from General Electric, looks set to continue these efforts. Despite its improved performance, we don't believe Spirit can extract excess returns over time because customers possess bargaining power. Although Spirit enjoys a stronger negotiating position today than in the past, the major aircraft producers still hold the cards. Most of its contracts include volume-based discounts, where Spirit receives less revenue per plane as production rises. Thus, Spirit must drive costs lower to maintain profitability. In addition, cost overruns require negotiations and these overruns do not always get fully funded. As goes Boeing, so goes Spirit. We estimate that work on Boeing's 737 aircraft alone represents around half of Spirit's revenue, and Boeing still controls a significant amount of Spirit's intellectual property. Boeing is ramping up 737 production from 42 per month currently to a target of 57 by 2019, which means Spirit will grow. In addition, we think Spirit's plans to diversify away from Boeing via its defense business and by winning more Airbus work will bear fruit. As part of this strategy, management announced plans to acquire Asco Industries for $650 million, which has Airbus and military exposure. Despite these positives, we maintain that the lack of a moat will restrain returns on invested capital over the longer term.