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Morningstar | Spirit is Attempting to Grow via Acquisitions and Defense Work

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. Because of its legacy as an internal Boeing supplier, Boeing accounts for around 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 improved the terms of its contracts with Boeing and other airframe manufacturers. His efforts resulted in solid performance, resulting in double-digit margins versus negative margins when he took over. The new CEO Tom Gentile, who took over in July 2016, hails from General Electric, and looks set to continue these efforts while also trying to grow the company's topline via acquisitions and a stronger push into defense work. Despite its improved performance, we don't believe Spirit can extract excess returns over time because customers possess bargaining power. Spirit enjoys a stronger position today than in the past, but the aircraft producers still hold most of the cards. Contracts include volume discounts, where Spirit faces pricing stepdowns as production rises; Spirit must drive costs lower to maintain profitability. In addition, aircraft manufacturers seem to be moving toward more vertical integration in higher end aerostructures like composites. As goes Boeing, so goes Spirit. We estimate that work on Boeing's 737 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, 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 should bear fruit. Recently, 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 over the longer term.