Friday, September 9, 2016

Update on the AIM Holding: Astronics Corporation (ATRO) by: Sarah Hillegass. "All Systems Go!"

Astronics Corporation (ATRO, $43.99): “The Value of Long-Term Investing”
 By: Sarah Hillegass, AIM Student at Marquette University
 Image result for astronics logo

Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

·         Astronics Corporation (NASDAQ: ATRO), headquartered in East Aurora, NY, manufactures products for the commercial and defense aerospace industries. Astronics has two product segments: Aerospace (80% sales) and Test Systems (20%).
·         The Aerospace segment has strengthened due to a strong backlog for electrical power generator systems and lighting systems. The Test Systems segment has struggled with deliveries to the semiconductor market due to legal and customer restrictions.   
·         The commercial and military industry outlooks do not offer signs that this is a cyclical industry downturn, but rather a softening of production volume increases due to slow global growth, which Astronics management has referenced as well.
·         ATRO ended FY15 around $40 but dropped to $25 when FY15 financial results were published in February. Since then, the stock has recovered to find resistance surrounding $40.
·         Our three-year time horizon allows us to wait for the turnaround in production lulls ATRO is currently facing. I would recommend a HOLD until further review in 1H17.

Key Points: Since, 2015’s annual report was published, Astronics Corporation has been focused on increasing shareholder value by revamping the Test Systems business and further stabilizing the Aerospace business to provide more reliable guidance. In early August, Astronics Corporation released 2Q16 financial results to highlight how this progress was coming. The quarter had a mixed response from investors. Whereas, the quarter highlighted record quarterly sales, operating profit, and bookings for the Aerospace segment, the Test Systems segment showed a quarter of discouraging comparisons to the year prior. Compared to 2Q15, sales in the Test Systems segment had decreased by nearly 46%. As a result, operating margins for the segment dropped from 24.1% to 4.9%. This was due to lower shipments and production volumes to the semiconductor market, with customers such as Panasonic and Apple.

Due to the mixed results, Astronics lowered revenue guidance for 2016. In the 2Q16 conference call, CEO Peter Gunderman shed some light on the weaker forecasts. He described how ATRO’s aerospace segment is heavily dependent on the aerospace aftermarket. Accordingly, guidance decreased due to doubts in the strength of the aftermarket because of decreased commercial production rates. The aerospace backlog is down from $352 million at July 4, 2015 to $294 million at July 2, 2016. However, the book to bill ratio for the segment remained slightly positive at 1.15 showing demand is still present. Due to this aerospace softness and lack of additional, concrete Test Systems plans for the semiconductor markets, guidance was lowered.

As one of Astronics largest customers at 13% of total sales, Boeing’s decisions heavily influence ATRO. According to an Astronics' Presentation at Drexel, ATRO has substantial content on each of Boeing’s platforms: 777 $235k, 737 $100k, 787 $45k, 747 $30k. From Boeing’s 2Q16 financial results, the 777 and 787 platforms are ramping up while the 737 and 747 platforms are having slight production cuts. On the whole, these cuts do not significantly impact ATRO in a negative manner due to the substantial content ATRO has on the 777 platform and narrow-body projects. Whereas the aerospace segment has nearly 80% market share for the in-seat power market (ISP) for wide-body aircraft, their growth will come from expanding their market share in the new generation narrow-body aircrafts.  

While all may seem to be slowing down, there is still long-term hope for ATRO. Boeing and Astronics have both mentioned that they do not believe there is a cyclical trough about to hit the aerospace market. However, 2016 will not perform as well as 2015 for new airplane orders and aftermarket sales. In late 2016, orders are forecasted to increase which will result in revenue recognition for as early as 1Q17. Additionally, new contract wins from three major Asian airlines will expand ATRO’s reach in Asia with a four year, $16 million contract for the EmPower in-seat power system. On the defense side, a July contract gained $5 million worth of night vision lighting system content on the F-16 military fleet. Furthermore, when the presidential election comes to a wrap in 4Q16, ATRO will be better able to predict military aerospace and test systems demand. Finally, CEO Peter Gunderman alluded to nearly concrete Test Systems contracts/product innovations that would start to hit revenue as soon as 1Q17.

What has the stock done lately?
ATRO has volleyed around $40 throughout the last three months. In late May, ATRO was near $40 after winning a Boeing 737 certificate for a Wireless Aircraft Interface Device. After stumbling to near $30, ATRO won contracts with three major Asian airlines for in-seat power systems and night-vision lighting for the F-16 fleet. Since then, ATRO has been on a steady incline. Even as 2Q16 results were published with positive Aerospace results, contrasted with dismal Test systems results, ATRO remained positively resilient climbing to soon break $45.

 Past Year Performance: ATRO has had a -1.42% total return over the last year. The year has been scarred by a shakeup in the semiconductor market, which was a large source of growth since 2014 through the ATS acquisition for the Test Systems Market. The substantial losses in this segment offset the substantial growth observed in the first half of 2016 for the Aerospace market. Additionally, as commercial airplane production rates were cut, so were the volumes in backlog for ATRO’s power generation systems and lighting systems, specifically avionics satellite antennas.

My Takeaway
The aerospace industry has a very transparent backlog. Therefore, holding ATRO does not give me many qualms due to the strong backlogs. However, since the typical contracts are yearlong for ATRO’s aerospace segment, there is more unease with the ability to properly forecast based on multi-year backlogs. Yet, the book to bill ratio shows there is still sufficient demand. Additionally, with increased margins in 2Q16, it shows there is no fundamental weakness in the aerospace segment besides the global slowdown. Also, in the grand scope of ATRO, the aerospace segment is 80% of sales. With a record quarter such as we have seen in Q2 and the last few quarters, I have no doubt that even with a little weakness, the segment will prosper. With only 20% of sales coming from the Test Systems business, any new deals or improvements that are expected for 2H16 and 1Q17 will provide significant relief.