Aerospace Parts Company Valuations – June 2022 Update
Following an increase in valuations in 2021, enterprise values for publicly-traded aerospace parts companies declined through June 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 not always 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 not touch on every observation 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. The effective date of this analysis is June 30, 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 June 30, 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 June 30, 2022 is consistent with the broad market downturn referenced earlier.
While broad economic uncertainties exist, the outlook for the industry is generally perceived to be better positioned than in 2020. Deloitte put together a report discussing the 2022 outlook for the aerospace and defense industry, which nicely summarizes various factors expected to impact the sector. Commercial air travel activity increased from the lows of 2020, and customer order activity for aircraft and parts has rebounded to a certain degree.
When the report was published, the emergence of COVID-variants was noted to keep demand for travel subdued into early 2022. However, a new headwind for the industry has emerged in the form of inflation, particularly rising fuel prices. The U.S. Travel Association indicated in its June 2022 Travel Data Report that 41% of American travelers now say that rising gas prices will greatly impact their decision to travel in the next six months. Nevertheless, the U.S. Travel Association expects that 48 million Americans traveled for the Fourth of July holiday weekend, which reflects an increase of 4% from 2021 and only 2% below 2019 levels. The continuing pandemic and inflation are critical uncertainties to shifting demand for aerospace parts.
Valuation Multiples
Figures 2 and 3 provide a view into the historical trend in valuation multiples (revenue and EBITDA).
Median valuation multiples fluctuated over the last five fiscal years and the LTM period. While the median revenue multiple increased in the LTM period, this is deceptive as most of the industry constituents experienced declines in their revenue multiples from LFY to LTM. 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 present a summary of the industry’s historical performance and consensus forecasts. Note that “NFY” means next fiscal year; NFY (blue line) = calendar 2022for most companies, NFY (orange line) = calendar 2021for most companies. “Current year” means data effective as of June 30, 2022, while “prior year” means June 30, 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. LTM EBITDA multiples are plotted against projected 2-year EBITDA growth rates in Figure 6.
We observed a tendency for companies with higher projected growth rates to trade at higher EBITDA multiples. We did not observe a meaningful relationship between revenue growth rates and revenue multiples.
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 7 presents a possible correlation between size (measured by market capitalization) and LTM EBITDA multiples.
The data in Figure 7 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, Mercury Systems, Inc. ranks among the smallest companies in the industry but trades at one of the highest EBITDA multiples. Analysts expect Mercury Systems’ EBITDA to at a compound annual growth rate of 12.1% over the next two fiscal years (one of the highest growth rates within the group of industry constituents). In this case, growth appears to have a more substantial influence on the company’s valuation multiple.
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 8 below.
There appears to be some correlation between LTM 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 9 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 9, 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. However, as was illustrated in this analysis, no one factor appeared to have a dominating impact on the magnitude of valuation multiples. These variances highlight the complexities of how investors are valuing these companies in a highly competitive and constantly evolving industry.
A summary of these observations is presented below and compared to our December 2021 analysis.
As noted 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 you found this analysis helpful. Any input, feedback, suggestions, and questions (including disagreements with my high-level analysis) are welcome! Thanks for reading.
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