Month: July 2015

Spirit AeroSystems – Q2 2015

Posted on by Travis Lane

Spirit had their 2nd quarter earnings report today, and it came alongside some exciting news: over the next two years, Spirit plans to repurchase $350M worth of their shares! Hooray! Who cares? Well… both Spirit’s investors and employees should care, since it means good things for both of them! I’ll talk a bit more about the share repurchase in the mini-lesson, but for now, you should know that it’s a good sign.

Before that, let’s talk about the call. As always, it’s worth listening even if you don’t necessarily understand all of the financial terminology, so if you missed it live this morning, I encourage you to listen to it on replay. As we usually do, let’s start with the handy financial results summary:

2015_Q2_1-Summary

Some things to immediately note. Revenue (money paid to us by customers) was down compared to this quarter last year. Two things primarily accounted for that. First, the Gulfstream divestiture. When we said we “weren’t making money” on the Gulfstream business, what we really meant was “not making profit.” We were getting paid for the work we were doing, and now we’re no longer doing it. Of course, without the drag on our profits, our margins are looking fantastic, meaning we’re a more efficient and profitable business overall, so we shouldn’t exactly mourn the loss of that revenue. Second, the 787 program experienced a price step-down, causing lower revenues. We talked about this loooong ago when the forward losses were coming out, because it was already costing us more to make those early planes than we sold them for, and if we didn’t fix that imbalance by the time the step-down hit, we’d have been in a whole new world of hurt. But it seems that we’ve come down the learning curve and are on a better course, so, while we like being paid lots of money, this loss of revenue seems expected and not worthy of concern.

On the rest, you’ll notice that even with reduced revenues, we saw incremental improvement on Operating Income (money left over after taking out the cost of planes that we built, sales, administration, and R&D), as well as net income (money left over after everything is accounted for). Our six month running net margin is almost 10%… which is really, really solid. Also noteworthy is that we paid less interest this quarter due to Mr. Kapoor’s refinancing efforts. Our interest expense in Q1 2015 was $17.9M; in Q2 2014 it was $20.8M. This quarter, it was $12.1M. Now if only I could refinance my house and put $5.8M in my pocket…

The last component is cash flow, of course. Profit is more or less in the aether, but how is Spirit’s savings account doing?

2015_Q2_2-CashFlow

Check out the cash balance at the end of the quarter. Uh, we’ve got almost a billion dollars in cash on hand. We generated $230M in free cash flow — money that’s left over at the end of the month — this quarter alone, and we stuffed $209M of it in the bank. And with our updated forecast, we plan to generate nearly half a billion more by year end. And this isn’t numbers on paper, it’s real folding money. Alright, digital numbers in a bank account, but you get the picture. Pretty cool.

While in previous quarters I’ve harped on and emphasized the importance of cash, there actually is a point where you can have too much. It’s a topic I’ll probably explore more thoroughly in a future lesson, but in short, the increases in Property, Plant, and Equipment (which are like home improvement projects for the company) and the share buybacks Spirit announced are intelligent uses of our beginning-to-be-excessive cash hoard.

As for the analyst questions, they were once again relatively tame and cordial, with a bit of company humor mixed in. Our boys at the helm were notably comfortable, a position that’s largely justified when sitting on numbers like we produced. I’ll share a couple of my favorite questions and answers and call it a quarter. As a side note, I take rather detailed notes of the Q&A section of the earnings calls; if anyone would like those notes leave me a comment or an email and I’ll provide them. Here we go:

  • Question: A350 deferred inventory per unit has been steadily decreasing… is it stabilizing or is there more improvement to come? Larry: Some of the big, early expenses are gone and change management is coming down, so some of the gains have been realized. However, what Spirit does best is go down the learning curve and get better as the rate increases. We’ll see further progress on unit cost and delivery as we start ramping up production. Travis: Deferred inventory is something that I came to fully understand just last quarter. I’ll probably compose another mini-lesson on that at some point. For now, know that deferred inventory is the precursor to forward losses, and that higher deferred inventory is bad. The biggest threat of deferred inventory comes early on in the production phase of programs when we’re trying to learn how to build stuff. Our top brass seems to believe that A350 production is on track and will continue to improve. The threat isn’t over, but it’s starting to shrink a bit.
  • Question: What’s the breakdown of capital expenditures? Where does the PP&E money go? Larry: $200M goes to maintenance expenses (he didn’t specify, but I assume that’s in a full year… either way, it’s a LOT!). This year we’ll probably spend $325-$375M on automation and improvements above and beyond simple maintenance. In the future, we would consider increasing capital expenditures considerably if it makes sense from an investment standpoint. Travis: When we talk about investing in ourselves, it’s not just share repurchases, it’s our home base too. I just found this to be an interesting question and absolutely crazy to think how much Spirit spends on keeping its high-capital business intact.
  • Question: A lot of previous questions have focused on the elephants in the room — A350, 787, Gulfstream — but how are the young programs doing? A350-1000, 737-MAX, 777X, and 787-10? Larry: “Our deliverables are delivering.” He thinks they’re all tracking to plan pretty well. These are all derivatives and you expect your ability to fulfill a derivative to be better than the original. We now have experience with Airbus, and we’re through the original 787, and the 737 and 777 are part of our longstanding business. So far, our young development programs seem pretty promising. Travis: Aha, now we know what people will be asking about when A350 and 787 are making the kind of money that 737 does currently. I was glad to hear this question because it indicates that the analysts are relatively satisfied with the company’s direction and performance on what were some of our toughest programs ever. They’re ready to move on to the future. Cool.
  • Question: It seems operations are under control and steady. So where do you want to take the company? Where do you see Spirit 5 years from now? Larry: Our goal has been to stabilize operations and be #1 in the industry. Our main goal is to deliver a high-quality product on time, whether the product is engineering or hardware. We do want to grow the business in line with stuff that fits with us. We’re looking at defense and would like that to be a bigger part of our business, but overall we have pretty tight definitions of what our business is and what we do. Our priorities are, in order: reduce costs, support increased rates for our customers, return value to shareholders, and pursue acquisitions if they make logical sense and it’s mutually valuable. Travis: I thought this was a really neat question and answer. I do wish though, that he had instead asked 5, 10, 20, 50 years out. I don’t suspect Mr. Lawson will be our CEO in 2065 (though in 2015 we drink to his well-being), but I am curious what he thinks Spirit is capable of over corporate eons. Maybe I’ll get my answer next time.

And that’s it! It was another great quarter… I suspect we’ll be hearing from Sam Marnick shortly with the STIP score, and I’d be extremely surprised if it was less than 1.1. But like always, don’t hunt me down with torches and pitchforks if I’m wrong.

In the meantime, good job everyone, I’ll bug you again next quarter!

Suggested Mini-Lesson

Returning Value to Shareholders

When I arrived at work this morning, I already had several emails and chats asking me about the share repurchase program that Spirit announced. Instead of responding one at a time, it made the most sense to just write up a thorough article explaining it to everybody! In short, share buybacks are one of the major ways that companies give back to their loyal investors. Check out the article, and feel free to email or comment with any questions!

Returning Value to Shareholders

Posted on by Travis Lane

The essence of capitalism is that the shareholders of a public company aren’t just “investors;” the shareholders legitimately own the business. It’s easy to forget, because you probably don’t play an active role in the companies that you’re a part owner of. Do you know how many companies you own a tiny sliver of via your 401(k)? Most investment strategies will include at least one index fund, most popularly an S&P500 fund, meaning you’ve got a piece of hundreds of different companies that you own. While many casual investors aren’t active in leveraging that ownership to make strategic decisions, they want the same thing as the people who are more involved: to make money on their investment in the company. You may not think of it that way often, but if you’re invested in a stock or mutual fund, you obviously want it to go up in value! If that weren’t your goal, you’d have that money in a bank account or a cash/stable value fund.

Different investors have different goals and values. Most are just people like you and me, investing money for retirement or major expenses like college for their kids or a house, hoping that our money is well-placed to grow and flourish in the market. Some are interested in controlling the company’s behaviors by electing members to the board of directors or even inciting proxy fights, where investors who are unsatisfied with one or more aspects of the company can gather up enough votes from other shareholders to elect new board members or convince existing board members to change their positions. Additionally, some investors are concerned with environmental or ethical issues, while others are simply there to maximize profits. Some investors are long-term driven, wanting to hang onto a company for a lifetime, while others want to capitalize on a market trend, boom, or fad, and harvest as much money as possible before dumping the shares. This isn’t an ethics discussion; it’s simply the nature of things that people have different wants, needs, and values that match their financial situations and personalities. Even among investors who are primarily focused on profit, there’s a major distinction between two types. These two types are both wanting the company to “return value to shareholders,” but have different preferences on how it should be done. Today’s discussion is on two major approaches to “returning value,” and the types of people who may prefer each.

Dividends

One way of increasing value to shareholders is to issue dividends. Dividends are cash payments that companies make to shareholders out of their profits. Coca-Cola (KO), a company famous for its long-term dividend policy, will pay investors $0.33 per share, per quarter in 2015.

Typically, dividends are issued by large companies who have limited growth potential. Coca-Cola has nearly worldwide market penetration. Try traveling somewhere where you can’t buy a Coke. As such, they don’t really need to reinvest a ton of their free cash flow. What would they invest it in? They’re a global, stable, cash-generating machine. In other words, they issue dividends because it’s the best way for their company to return value to their shareholders.

So what kind of investor prefers dividends? Conventional investing wisdom suggests that people approaching retirement should shift into more blue-chip companies — big guys like Coca-Cola that probably aren’t going anywhere anytime soon — to protect their invested assets and to replace their incomes with dividends upon retirement. Many retirees look to annuities, where they turn their lump sum investments into regular, steady cash flow to live off of after they stop drawing a paycheck. A dividend-heavy portfolio accomplishes something similar, with greater risk because the stock can decline, but also greater potential since the company can still appreciate in value or increase their dividend payout.

As an example, if someone wanted to make $100,000 annually in retirement, they could do a calculation to see how much Coca-Cola stock they needed to own to produce that. At $0.33 a quarter, each share of Coke makes $1.32/yr. You would need 75,758 shares to make $100,000 in 2015. At the time of this writing, Coke’s share price is $41.08, so to generate a $100k annual income, you’d need around $3.1M in Coke stock. That’s a lot of money, but you can see how dividends could play an integral part in someone seeking to get cash back out of their investments while preserving their value (and even continuing to grow it).

Share Repurchases

An alternative way for companies to increase shareholder value is to purchase their own shares off the market. There are a couple different ways to do this, and some other reasons besides shareholder wealth that companies may buy back shares, but generally, the results are the same: the company’s value stays the same, but since there are fewer shares, the value of each share increases. This directly puts more money in the investors’ wallets.

Here’s an example. Let’s say a company has 50,000,000 (50M) shares on the market at a price of $100 each. The company’s market cap (total value) is 50M shares times $100/share, so $5B. If the company purchased $100M of their shares back, they would remove 1M shares from the market. There are now 49M shares outstanding. The company is still worth $5B total though, so the share price will adjust accordingly — $5B divided out over now 49M shares instead of 50M equals $102.04 per share. The share repurchase gave an immediate 2.04% return on every outstanding share. Not bad for a day’s work! There used to be another reason shareholders preferred repurchases over dividends. It used to be that dividend income was taxed at normal income tax rates, while share appreciation was subject to the lower long-term capital gains tax rate. That changed in 2003 so dividends are now taxed at the capital gains rate.

You might have already guessed what kind of investor or company prefers increasing share value over cash payouts. Not surprisingly, it’s the opposite of the dividend-preferring crowd. Younger, more aggressive investors want share values to increase. They’re still working and investing for the distant future. They want their investments to compound, and they don’t care about cash, since they’re not planning to use it for decades! Also, while large companies with high levels of market penetration are more likely to generate dividends, since they don’t have a lot of growth potential even with massive reinvestment, smaller companies benefit tremendously from reinvesting in the value of the company and its future growth.

The Bottom Line

At the end of the day, when a company exercises either of these options, it’s usually a signal of strong earnings and solid financial standing. Different companies, different boards of directors, and different people will want different things out of their investments. But if your company is putting a high priority on “increasing shareholder value,” it generally means that things are pretty stable on the homefront.

As you listen to your earnings in the future, listen for investors to start calling for these options, directly or indirectly. As I always emphasize, it’s the intangibles that make earnings calls interesting. If your analysts are concerned about the future of the company, it signals one thing. If they’re seeing dollar signs, they’ll start to ask for a piece. See if you can catch it next time you listen in!

For more information on share repurchasing, see: http://www.investopedia.com/articles/02/041702.asp