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This aero-structure company’s EPS forecasts were increased by 13 analysts in the past 30 days.

This aero-structure company’s EPS forecasts were increased by 13 analysts in the past 30 days.

Spirit AeroSystems Holdings, Inc. (SPR)
From Canaccord Genuity Research

Spirit AeroSystems Holdings, Inc. (SPR) posted adjusted Q2/17 EPS of $1.57, as compared to our estimate of $1.24 (note the quarter included a one-time $2.05 charge associated with a forward loss charge on the 787). FCF was better than expected in the quarter at $175M, and revenues were basically flat.

SPR announced that it has reached an agreement on the master contract negotiations with Boeing. While the final details of the agreement are due to be signed in Q3/17, management announced the completion of the Memorandum of Understanding (MOU), and reflected the revised terms in the accounting assumptions and the 2017 financial guidance, indicating that the company is very confident this agreement will be finalized this quarter.

As part of the agreement, the company recognized a pre-tax $353M reach forward loss position on the 787. SPR will now have pricing step-downs on the 787-9 and -10 through line unit 1,405. The agreement also includes pricing step-downs on the 737 MAX based on volume. Note that the cash burn on the 787 over the next ~800 units will be greatly weighted on units 1,000 to 1,405 (the program is generating FCF in 2017) and the cash burn will be greater than the $353M forward loss, but likely ~$450M-$500M. The agreement covers deliveries through 2022.

Now with the MOU in place, and that overhang lifted, the focus will return to operations and sentiment on the sector, both of which are improved. The core operational performance was one reason the company raised its 2017 guidance, and also indicated that its long-term FCF/sales target is now 7%-9%, up from the previous range of 6%-8%. Both FCF and revenues are expected to increase in 2018, and the initial view on 2018 capex is that it will largely remain at 2017 levels. Maintenance capex is ~$200M, highlighting the growth investments at current spending levels.

Much of the focus now for SPR is on the 737. We believe the outlook for the 737 remains very strong, and the recently improved confidence in the commercial aerospace cycle largely reflects the very healthy outlook for the narrow-body aircraft. For SPR, we believe the 737 accounts for ~50% of total sales, and over 80% of profits. As part of the Boeing agreement, SPR has agreed to 737 MAX pricing, and has also agreed to volume discounts as rates go up to 57/month in 2019, and the company has agreed to share on-going 737 productivity gains with Boeing. Even with the additional concessions, we believe margins on the 737 have room to expand, we continue to expect this program to be a source of upside as rates do increase.

We are not surprised by the surge in SPR stock today on the strong quarter results and, more importantly, the initial master MOU with Boeing. We are raising our price target to $80, which is based on the blend of a 15x EPS multiple and a 12.5x EBITDA multiple, applied to our 2018 estimates. We believe that with the overhang of the master contract negotiations behind it, the stock will benefit as the focus turns to the core performance and FCF potential. We continue to see significant opportunity to improve the cost structure and margins (supply chain, purchasing, automation, tooling) and believe this will get reflected into the outlook over time. Moreover, the increase in the buyback authorization ($792M remaining), recent insertion of a dividend, and other potential organic investment opportunities will also be positive catalysts for the stock.

Ken Herbert, Canaccord Genuity Research,, August 2, 2017