Chapter 12 article Well written but I'm not buying shares because of the shareholder concentration.
Magellan Aerospace: Commercial Aerospace Recovery Could Drive 100% Upside with Good Downside Protection from Balance Sheet
Note to readers: This is the first in a new series entitled “Applications Rejected by MicroCapClub”. For those unfamiliar with MicroCapClub, it bills itself as “an exclusive forum for experienced microcap investors focused on microcap companies”. As with any exclusive club, one must apply for membership. The applications are first screened by the administrators of the website and then put to a members vote. Despite my best efforts, your author continues to find himself on the outside of this prestigious online institution. While this is the first of my rejected submissions that I have published on Chapter Twelve, it is in fact the third time I have been denied entry. Don’t fear – I remain resolute in my determination to gain admission and will continue to apply. In the (likely) event that I am again rejected, well, all the better for Chapter Twelve readers!
Magellan is a diversified aerospace supplier with significant upside potential from the recovery in commercial aerospace and good downside protection from hard asset value on the balance sheet. Magellan revenue fell 30% through covid as the commercial business was cut almost in half while defense remained relatively stable. With Boeing and Airbus narrowbody build rates expected to ramp back up to pre-pandemic levels by late-2023 (though widebody production will remain lower), Magellan’s financial performance should move back towards the pre-pandemic $1.00-$1.50 EPS range, putting the stock at 5-7x normalized EPS. The downside is well-protected as the stock trades at 0.63x TBV and 1.25x NWC with zero net debt and effectively break-even to slightly positive FCF (excluding government assistance) in 2021 despite depressed industry conditions.
Canadian Natural Resources Executive Chairman Murray Edwards is Chairman of Magellan and owns 75% of the equity (worth $300 million). Over the past couple years, Magellan has been repurchasing shares for the first time in its history when the stock is below C$7.60. A privatization by Murray Edwards seems like a logical outcome with the NCIB indicating he believes the shares are currently good value.
Magellan and its predecessor Fleet Industries have a multi-decade history in Canadian aerospace. Today, the company operates 19 facilities across Canada, the US, Europe, and India. The company’s operations are concentrated in aerostructures and aeroengines (including repair and overhaul work for the military). Aerostructures tends to have a relatively lower aftermarket component vs. other parts of the airplane, leaving Magellan exposed primarily to new aircraft production rates. Defense accounted for about half of the company’s revenue in 2021, up from about one-third pre-covid as commercial revenues fell by roughly 50% because Boeing and Airbus scaled back production. North America accounts for about two-thirds of revenue and Europe is the balance. In recent years, Magellan sought to control its cost base by investing in lower labour cost operations in India and Poland.
The table below shows aircraft production rates at Boeing and Airbus over the past few years as well as expectations for 2022 and 2023. Demand for narrowbody aircraft (737 and A320) is robust with both Boeing and Airbus anticipating narrowbody production rates to match or exceed pre-pandemic levels in 2023. Widebody conditions are worse with production rates there expected to remain subdued. Magellan’s defense business may enjoy a tailwind from the potential finalization of Canada’s $15B+ F-35 purchases in 2022 after many years of delay. As a Canadian manufacturer, Magellan should be well-placed from a local content perspective to work on the order.
Prior to covid, Magellan consistently delivered EPS in the $1.00-$1.50 range and EBITDA of $100-$160 million. A recovery to this range would put the stock at 5-7x EPS and 2.5-4.0x EBITDA as compared to historic averages of 10-12x EPS and 6-7x EBITDA. A re-rate to average multiples on normalized earnings would drive 100% upside to the stock.
The downside on Magellan is well protected. Tangible book value sits at $11.67/share and net working capital after debt is $5.85/share. The current share price is $7.40. At 0.63x TBV, Magellan is within 10-20% of the lows seen over the past decade. Further, the company weathered the covid downturn well by generating break-even to slightly positive FCF in 2021 excluding government subsidies and normalizing for a large working capital draw. Over the past couple years, Magellan has been repurchasing shares up to $7.60.
The company maintained its quarterly dividend of $0.105 per share through covid, but reduced it to $0.08 in May 2022 citing widebody weakness, inflation, and supply chain challenges. The stock sold off by 20% on Q1 results, which included the dividend cut. Magellan restarted the buyback after the shares fell, repurchasing $520k worth of stock to late July. The Board then cut the dividend by a further $0.03 to $0.05 per share in early August, citing the same factors in spite of a 15% bounce in Q2 revenue and 20% growth in EBITDA.
Magellan Chairman Murray Edwards owns 75% of the company. He has been Chairman and the largest investor in the company since 1995. Murray acquired the bulk of his holdings through a convertible debenture that rescued the company from financial distress in 2009. Magellan behaves like a private company with no quarterly calls and limited investor disclosure. With a float of only $100 million and an under-levered balance sheet, Murray should privatize the company and the implementation of the NCIB in 2020 (the first in the company’s history) indicates his view that the shares represent good value.
Disclosure: the author owns shares in Magellan Aerospace.