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The recovery in commercial aerospace is real, but it’s proving to be a drunken momentum rather than the smooth upward trend favored by major OEMs. airbus (OTCPK:EADSY) and Boeing (Bachelor) have struggled to balance uneven production rates and capacities among suppliers, and those suppliers (and OEMs) have reduced parts/supply availability, input costs, labor availability, and It continues to struggle with everything you want to name. Adds operational challenges (some self-harm, some not). Universal Stainless & Alloy Products (NASDAQ: USAP) (“Universal Stainless”) struggle to make the most of these still nascent recoveries.
Down about 10% since the last update, Universal Stainless lags behind other material and component suppliers in the aerospace industry. carpenter (CRS) has done really well during that time. ATI (ATI), hexel (HXL), and Howmet (HWM) It was ‘okay’ rather than great.
I never thought Universal Stainless was the best operator, but over the years in many cyclical industries we have seen that long-term upswings tend to lead to dramatic improvements for less capable operators. I’ve been here. While this is by no means the best product or long-term holding, I believe this untracked, low-trading specialty steel supplier can generate attractive returns for more aggressive investors. I’m here.
Uninspired Q3 numbers are useless
The overall reaction to third quarter earnings in this area is not as great. Many companies are still struggling with costs and erratic production schedules due to general disruptions in the commercial aircraft supply chain and unclear build rate plans. From Airbus and Boeing. Still, Universal Stainless didn’t have the third quarter I wanted.
Revenues increased 24% year-on-year, down 11% quarter-on-quarter to $46 million; specialty steel sales increased 21% year-on-year, down 13% quarter-on-quarter to $37 million; high-grade steel alloy sales decreased 36% year-on-year $8 million, up 9%. Overall volume decreased approximately 4% year-on-year and 19% quarter-on-quarter, while average realized price increased 29% year-on-year and 9% quarter-on-quarter to $3.90/lb.
The company struggled to overcome labor and supply challenges after seeing the lingering impact of the metal spill last quarter, and saw negative volumes as a spike in COVID-19 cases impacting worker availability. was a factor. Had the company met my volume increase target, the company would have actually beaten my quarterly earnings target as pricing was a little stronger than expected.
In a volume-driven business, low volume means inefficient operations, and that was true in the third quarter. Gross margins still improved 20bp year-on-year, but fell 270bp to 6.4%, with a mismatch between metal costs and surcharges weighing on his 320bp performance (delays are not uncommon in business).
Operating costs remained well contained, with Adjusted EBITDA growing 11% year-over-year, although this number was down 35% sequentially. Margins were 9.1% in the quarter, compared with 10.2% in the prior year period and 12.3% prior to the quarter. As an aside, I’m reporting the company’s version of his EBITDA, adjusted, but I use a different version for the valuation (not excluding stock-based compensation or cost-absorbing expenses).
Demand exists, but delivery remains opaque
Universal Stainless saw sales to aerospace customers increase 42% year-over-year, but were down 11% sequentially. ATI was up 122% year over year, Carpenter was up 40%, and Howmet was up 23%. all increased consecutively). Universal Stainless also recorded strong orders, with the company’s backlog up 97% year-over-year and 11% quarter-on-quarter to $246 million, or 5.3 times quarterly sales, while its premium alloy backlog It was up 28% year-on-year.
The commercial aerospace supply chain is currently in disarray, with ripple effects for everyone in space. Boeing’s recent investor day was less clear, other than indicating that engines aren’t as much of a stumbling block as they used to be. 38/month (probably later next year). Likewise, Airbus hopes to build more than 50 of his A320s a month, but it also has supply chain problems.
Boeing may not have trouble sourcing engines for the 737, but that’s not always the case in the general commercial aerospace market. Textron (TXT) is struggling to meet demand due to an inadequate supply of engines, with other suppliers talking about lead times of nearly a year for titanium parts and engines.
Unfortunately, Universal Stainless is not involved with titanium. They have the facilities to participate and are willing to do so, but certification takes time (usually about two years). This means that Universal Stainless has not been exposed to the most demanding materials (such as titanium), and engine availability is likely to drive production schedules, resulting in periods of uncertainty in order/delivery schedules. is likely to follow.
Universal Stainless also sees choppy results in other markets, with consecutive double-digit declines in heavy industry, oil/gas, and power. Initially, I thought the company might have reassigned capacity to fulfill aerospace orders, but that doesn’t line up with what management said on the phone. They weren’t the only ones to see continued weakness in the category.
Outlook
We have decided to be more cautious about our earnings assumptions for the next few quarters. Management says workforce availability is improving, but there’s not much reason to be aggressive at this point.It has lowered its earnings estimates by about 9% in 2022 and about 2% in 2023. but added some in later years. Extended recovery in commercial aerospace. However, we continue to expect revenues to double from 2021 to 2025, and against the backdrop of this multi-year aerospace cycle (and the opportunity for Universal Stainless to expand into a variety of sectors), long-term revenues Growth is still in the single digits. like a hotside engine).
The company shouldn’t see the same level of gross margin pressure next quarter, but it has revised its full-year estimates lower because the company isn’t getting the leverage of the scale I expected. , which takes more than 3 points from our EBITDA margin estimate for this year, my estimate for 2023 is still around 13% (12.7% instead of 13.2%). As the cycle progresses, Universal Stainless firmly believes he can enter his mid-teens. If the company can actually increase its gross margin, it could probably go higher. Increased sales of premium alloys are likely compared to past cycles.
These stocks still look undervalued on a discounted free cash flow basis, but I prefer a DCF-based valuation because free cash flow is difficult to model in a cyclical commodity business. , I tend to use it as an indicator of “undervalued/overvalued” rather than overvalued. Reliance on specific numbers. Still, I think the stock is undervalued by more than 20% with this approach.
My preferred method is EV/EBITDA, and using a multiple of 6.5x for the 2023 EBITDA number, today’s fair value is just under $13.
Conclusion
The stability and predictability of the commercial aerospace market is great, but I don’t think that will be the case until at least the second half of 2023. In the meantime, Universal Stainless will certainly increase volume and achieve attractive margins. I think the opportunities are there. Also, I think the stock continues to be undervalued for its impact on this commercial aerospace recovery, but this is a cyclical/thematic deal, not a buy-and-hold investor idea. There is none.
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