Aerospace Parts Company Valuations – December 2022
Following an increase in valuations in 2021, enterprise values for publicly-traded aerospace parts companies declined through the end of 2022. This decrease coincides with the recent deterioration in the overall equity markets and heightened uncertainty around the health of the U.S. and global economies. This article will examine some factors that appear to impact valuations in this industry.
Important notes: This article examines potential driving factors for aerospace parts company valuations from a financial statement perspective. An actual business valuation requires an in-depth analysis of the business operations and associated risk factors that are only sometimes evident from the data on financial statements. Also, to keep the length manageable, this article will focus on what the author interpreted as the primary value drivers. It will only touch on some observations in the data. For a quick read on the basic concepts of risk and return and how they apply in the context of this article, please visit: What is Value? and Risk and Return in the Market Approach.
The industry constituents for this analysis are listed below. RADA Electronic Industries Ltd. was removed from the group for this update as it was acquired via a reverse merger. The effective date of this analysis is December 28, 2022.
Figure 1 summarizes three items for the aerospace parts companies:
- Total enterprise value calculated as the sum of market capitalization and interest-bearing debt less cash;
- Median revenues; and
- Median earnings before interest, taxes, depreciation, and amortization (“EBITDA”).
The latest fiscal year is notated “LFY” (calendar 2021), while the latest 12-month period is labeled “LTM” (latest available information as of December 28, 2022).
Valuations oscillated over the last five fiscal years and the LTM period. While revenue growth was gradual over the period analyzed, EBITDA increased more consistently through the LFY period. In the LTM, revenue and EBITDA growth stagnated while valuations generally declined. The decline in valuations through the end of 2022 is consistent with the broad market downturn referenced earlier.
Looking deeper, the stagnation observed in valuations and financial performance may be attributed to supply chain and labor issues, which restricted the industry’s ability to grow in 2022. Deloitte put together a report discussing the 2023 outlook for the aerospace and defense industry that nicely summarizes various factors expected to impact the sector. The Russian invasion of Ukraine caused significant disruption to global supply chains. The war affected the availability of critical metals and rare earth elements and caused significant volatility in fuel costs during 2022.
While these factors continue to pose some risk to the industry, Deloitte’s outlook survey indicated that 88% of surveyed senior executives believed the outlook for 2023 to be “somewhat to very positive.” As will be seen later in this analysis, the industry is expected to generate strong growth over the next several years.
Valuation Multiples
Figures 2 and 3 provide a view of the historical trend in valuation multiples (revenue and EBITDA).
Median valuation multiples fluctuated over the last five fiscal years and the LTM period. Median revenue and EBITDA multiples increased in the LTM period. However, The trends in median multiples can only tell us so much. Let’s dive into what is impacting valuations.
The Growth Story
Growth often has a strong influence on how companies are valued. Figures 4 and 5 below summarize the industry’s historical performance and consensus forecasts. Note that “NFY” means next fiscal year. NFY (blue line) = calendar 2022 for most companies, and NFY (orange line) = prior year projection of calendar 2021 for most companies. “Current year” means data effective as of December 2022, while “prior year” means December 2021.
In Figure 4, the orange line represents data as of June 2021, while the blue line represents current data. Growth expectations as of June 2022 were generally consistent with those as of the prior year. The industry expects substantial growth rates, which do not appear to have been impacted by a growing negative sentiment surrounding the U.S. economy and market conditions (yet).
We looked to identify a meaningful correlation between growth and observed valuation multiples. Companies that generate high levels of growth often trade at higher multiples than their lower-growth counterparts. LTM revenue and EBITDA multiples are plotted against projected 2-year revenue and EBITDA growth rates, respectively, in Figures 6 and 7.
We observed a tendency for companies with higher projected growth rates to trade at higher valuation multiples. However, there were outlier data points in both Figures 6 and 7.
See also: Need to prepare financial statement projections? See A Practical Guide to Financial Statement Forecasts for Business Valuations.
The Size Story
Larger companies are generally perceived to have lower levels of risk relative to smaller companies. This dynamic can be due to several factors, including improved product or geographic diversification, deeper management teams, access to various distribution channels, and better availability of capital.
Figure 8 presents a possible correlation between size (measured by market capitalization) and LTM EBITDA multiples.
The data in Figure 8 suggests that larger companies trade at higher valuation multiples. However, we noted significant dispersion in the valuation multiples of the smallest companies (less than $5 billion in market capitalization). For example, Innovative Solutions and Support, Inc. ranks among the smallest companies in the industry but trades at one of the highest EBITDA multiples.
The Profitability Story
Revenue multiples are typically heavily influenced by profitability. We usually observe higher revenue multiples in companies with higher levels of profitability. This relationship appears to hold for the aerospace parts industry, as shown in Figure 9 below.
There appears to be some correlation between NFY revenue multiples and NFY EBITDA margins, suggesting that more profitable companies trade at higher revenue multiples.
The Leverage Story
Debt usage tends to increase financial risk to equity holders. Debt holders have a senior position within a company’s capital structure, and debt servicing occurs before any cash flow benefits (i.e., dividends) are issued to equity holders. Figure 10 plots LTM revenue multiples against their associated interest coverage ratios (as available).
Interest coverage ratios measure a company’s ability to cover its ongoing debt costs with operating income from the business. In Figure 10, companies with better interest coverage (i.e., EBIT divided by interest expense) tended to trade at the highest revenue multiples.
Tying it All Together
The trends observed in this article suggest that growth, company size, profitability, and leverage all influence (to some degree) public aerospace parts company valuations. These observations are summarized below and compared to our December 2021 analysis.
As mentioned earlier, the industry experienced declines in market values for the sector despite relative consistency in expected growth rates. This would suggest that valuations declined primarily due to broad changes in the overall equity markets and deterioration in investor sentiment toward equity securities rather than company-specific expectations. Nevertheless, investors still appeared to price companies in this industry based on their underlying financial performance – just at lower overall valuation multiples.
I hope this analysis is helpful to you. Any input, feedback, suggestions, and questions (including disagreements with my high-level analysis) are welcome! Thanks for reading.