Business: The Triumph Group is a roll-up of a number of different businesses that provide aerospace structures, components, and systems to OEM and aftermarket customers in the business jet, commercial, and defense end markets. In 2010 Triumph acquired Vought Aircraft, a Tier 1 aerostructure supplier who was a major supplier to the Boeing 747. Following the Vought acquisition, Triumph was a complete multi-tier supplier, capable of providing large structures, build-to-print components, and proprietary products to OEMs and their suppliers. The business currently operates across 4 segments, detailed below.
Triumph began to run into numerous operational issues at a time that coincided with production rate cuts of their largest program by far, the 747. The resulting difficulties have led declines in organic sales, depressed margins, multiple management changes, and a >75% fall in the stock price. The business is currently in the midst of its most recent but perhaps most intense restructuring, after hiring Daniel Crowley (ex-Lockheed / Raytheon) as the CEO on 1/1/16, who has almost completely replaced the previous management team.
Aerospace Structures (39% of Sales, 29% of EBITDA): Triumph’s Aerospace Structures segment is comprised of operating businesses that produce composite and metal wings, fuselages, fuselage panels, nacelles and pylons, typically for OEMs. Major programs include: the Gulfstream G280/G650 (acquired from Spirit), the G450/G550, the G500/G600, Bombardier’s Global 7000/8000, Embraer’s E-Jet E2, and the Boeing 747 and 767 Tanker. The Bombardier Global and E-Jet E2 are Triumph’s two major development programs. The profitability of the Aerospace Structures segment (currently 11-13% EBITDA margins) has been depressed as a result of major production rate cuts and other operational issues, and profitability peaked at around ~18-20% EBITDA margins in 2012/2013.
Integrated Systems (27% of Sales, 45% of EBITDA): The Integrated Systems segment is comprised of operating businesses that primarily produce proprietary components and subsystems, such as gearboxes, fuel pumps, transmissions, flight controls, and more. Sales are split roughly 80% / 20% between OEM and aftermarket customers. The Integrated Systems segment is more skewed towards the narrow-body side of the market, with the A320/A321 and 737 being the largest two programs in the backlog. About ~30% of Integrated Systems sales go to the defense end market.
Precision Components (26% of Sales, 13% of EBITDA): Triumph’s Precision Components segment is geared towards supplying the other segments of the business, specifically aerospace structures, and also provides build-to-print products and composite and metal fabrication for both external suppliers and OEMs. The segment derives the majority of its revenues from the commercial end market, with major programs including the 777, 787, A350, 737 and A320. Like the Aerospace Structures segment, profitability has been depressed, with EBITDA margins averaging ~6.5% vs. historical 18-20% normalized EBITDA margins.
Product Support (8% of Sales, 13% of EBITDA): Triumph provides third party MRO and replacement part services through its Product Support segment. This segment doesn’t contain any proprietary products and as a result lacks the same high Gross and EBITDA margins that proprietary aftermarket services enjoy.
Investment Thesis: Triumph is a remarkably cheap business at trough multiples on trough margins that is turning the corner on its way to being a steadily profitable aerospace supplier.
- Triumph is cheap, trading at 5.9x forward EV/EBITDA vs. peers at 11-12x. It is cheap for a reason – it has a history of a multitude of operational issues, including production rate cuts on major programs (specifically the 747), numerous delays, excess costs associated with development programs, and botched execution of production line moves.
- To turn the business around, Dan Crowley assumed the role of CEO at the start of 2016. He has replaced the majority of the senior management team, and has brought a new mindset and viewpoint to Triumph that it has desperately needed to change the culture of the business. He has already instituted a number of changes in his first few months that have largely gone unnoticed, including multiple facility closures, divestitures, and large reductions in headcount.
- Over the past few years, Triumph has suffered from a bloated cost structure and contracting margins. Crowley has stated his goal is to remove $300m of costs, or ~10% of the total cost structure by 2019 through rationalizing the supply chain, cutting headcount, and reducing the manufacturing footprint.
- Triumph has been experiencing negative organic growth for some time due to poor operating performance, shifting Triumph to ‘no-bid lists’ due to quality and on-time delivery issues. TGI is eliminating these operational issues to be able to bid on new content and turn the corner to positive organic growth.
- The poor operational performance of the company isn’t the only reason it’s cheap. Triumph is viewed as a perpetual turnaround with no hope of recovering, it has a small (~$1.5bn) market cap leading it to be underfollowed, it’s levered with $1.1bn of net debt ex-pension liabilities (2.6x forward EBITDA) on the balance sheet, and it has traditionally been opaque with regards to shipset content and other metrics, making it difficult to forecast the business.
Currently, the business is trading at $31.60/share, which is 5.9x FY 2017 EV/EBITDA, and 8.2x 2017 P/E. Comparatively, peers trade at 11.7x forward EV/EBITDA, and 20.0x forward P/E. Triumph’s multiples, while low, are still on depressed margins, with 2017 EBITDA margins at 12.5%, versus a historical peak of ~19%. Assuming a slight re-rating to 7.0x EBITDA and 12.0x P/E (still well below peer average) and using 2019 EBITDA of $504m (15.6% margin), Triumph would be worth ~$54.75/share, a 73% premium to the current price, or a 20.1% IRR. If Triumph were to trade at peer multiples (which would likely never happen due to the negative perception of the business vs. peers), Triumph would trade at ~$102.00/share, a 225% premium to the current price, or a 48% IRR.
(EBITDA price targets assumes modest deleveraging from $1.1bn of net debt to $827m in 2019, and a share count of $49m)
(All numbers are in $’000s, except per-share data, unless otherwise noted)(Source: Company filings for historical financials, author estimates for forward years)
What Has Gone Wrong: Before understanding how the business can improve – it is important to understand what has gone wrong to lead the business to be as cheap as it is. Also, the improvements the management team are implementing are ones of culture and mentality as much as they are of operations. This change in culture will be what allows for the turnaround to succeed.
First – Triumph gave too much autonomy and too little accountability to its operating businesses. Triumph’s core philosophy was “to protect the integrity of the individual companies and the products and services they provide, while offering each company the advantage of being part of a larger entity.” This was somewhat true, as the 47 different operating companies were largely left to their own devices, to protect the ‘small company’ feel, and ‘entrepreneurial spirit’, but Triumph didn’t fully lend them the advantage of being part of a larger entity. Decentralization – to an extent – can be an effective tool when operating a collection of businesses like Triumph, but Triumph neglected to centralize many of the functions that would enable true economies of scale and scope across the operating businesses.
Second – Triumph experienced serious issues resulting from production rate cuts on its largest program, the 747. The biggest issue wasn’t that the program lost a large portion of total sales, it was the impact that a production rate decrease had on the cost side. There were enormous fixed costs behind the 747 – Triumph had two entire facilities with a cumulative manufacturing footprint in excess of 2.1m square feet (20% of the total Aerospace Structure square footage, and 15% of Triumph’s total square footage), and over 1,000 employees (about ~7-8% of the total workforce) dedicated to this single program. With the production rate cut from 2 per month down to 0.5 per month, the fixed costs were multiplied 8x per unit. Not only that, but Triumph had to deal with renegotiating supplier contracts that were previously set for a production rate of 2 per month. At a rate of 1.5 per month, Triumph was approximately breakeven, implying there was about ~$450m in costs based on a shipset value of $25m.
Source: Author estimates based on comments from 2014 Q4 and 2015 Q3 TGI Earnings Calls)
Third – Triumph attempted a major facility shift during the production rate cuts in the 747. Triumph used to operate out of the 5m square foot Jefferson Street Facility in Texas – an old WWII base with 300 acres, 163 active restrooms, 619 in-plant vehicles, 7,700 air filters, a 24/7 powerhouse, an in-house waste treatment facility, and 3D ionized water facilities. To avoid the recurring cost of maintaining such a facility, Triumph moved all of their programs (which included some major programs like the Bombardier Global, Embraer E2, and the C-17) from the Jefferson Street facility to a brand new location in Red Oak, Texas, a few miles down the road. Despite the proximity, the transition created multiple issues from production delays to unexpected moving and re-tooling expenses. While the end result was a beneficial one, the difficulty of the move highlighted the execution risk in moving/consolidating production facilities, and the costs that can be associated with inefficiencies created by move in production.
Lastly – Triumph has had some issues with their major development programs – the Bombardier Global 7000/8000 and Embraer E-Jet E2. Bombardier has been the main issue – and while Triumph’s job was relatively easy (a standard metallic transonic wing, nothing too technologically ground-breaking), Bombardier changed the design of the plane multiple times, creating additional cost headwinds for Triumph. It also led to a delay in the expected launch of the program, from an expected 2014/2015 entry into service (EIS) to a 2H’18 EIS. The result was an impairment charge and write-down of capitalized pre-production costs in inventory. Triumph has sued Bombardier for ~$350m, and is currently in talks, while still producing the Global wing. (See Risks – Development Programs for information on the suit).
(Source: Company filings)
Management: The management team will be the single most important factor in whether or not the business can turn around. Triumph has had 3 CEOs recently – the first was Richard C. III from 1993-2012, and 2015-2016. Jeff Frisby replaced Richard C. in 2012 until he was removed in 2015. Frisby was a company insider – he had been with Triumph since his own business, Frisby Aerospace, was acquired in 1998. In 2012, Frisby attempted to begin restructuring the business, but didn’t set his goals high enough. His plan was to take out $20-$50m of costs, and as small as that is (compared to a ~$3.0-$3.5bn cost structure), it was really all talk. EBITDA margins have decliend every year since 2013, and even if they took their planned costs out, it would be inconsequential (not even 100bps of margin improvement). As the business deteriorated, Frisby was let go, Richard C. re-assumed his role as CEO until Triumph hired Dan Crowley (ex Lockheed / Raytheon). Crowley checks the single most important box – he is a company outsider. Crowley brings a fresh and unbiased pair of eyes to the situation, and has cleaned out most of the senior management team. Triumph’s turnaround is clearly his opportunity to make a name for himself. At the end of the day, Crowley seems to be set on taking the steps necessary to put through serious change.
Cost Rationalization – The Supply Chain: Crowley has identified three main areas for achieving his $300m cost savings goal. The first, which is expected to make up ~$150m of savings, is rationalizing the supply chain. The second is reducing the manufacturing footprint, and the third is cutting headcount. To facilitate all three of these initiatives, an overarching goal to reduce the number of operating companies from 47 to 22 in order to simplify the business.
The supply chain is the largest source of potential savings. In line with the decentralized business model, much of the sourcing has been done at the operating company level. This had led to numerous inefficiencies, redundancies, and an inability to exert scale and purchasing power on suppliers. Triumph is on the path to doing three main things to better simplify their supply chain, the first is to centralize the sourcing process, the second is to reduce the total number of suppliers, and the third is to make better use of vertical integration.
By centralizing the sourcing process, Triumph can better exert superior purchasing power that comes from being a larger company, rather than a multitude of much smaller operating businesses. Triumph has launched their own version of Boeing’s “Partnering for Success” initiative, in which they work with their upstream partners to reduce price while maintaining margins. The success of this initiative will be dependent on Triumph’s ability to leverage their scale.
In Triumph’s “Partnering for Success” initiative, they identified 836 suppliers they deemed large enough to work with. This implies that there are an additional number of suppliers who are not large enough to merit working with to cut costs. While there is a benefit to having such a diversified supplier base in that it minimizes the dependence on any single supplier, simplifying the upstream channel and eliminating redundancies can lead to additional cost savings.
Lastly, vertical integration provides a key opportunity to lower input costs. Triumph has a number of composite and metal fabrication businesses which are well suited for supplying both internal operating companies and external suppliers/OEMs. Through consolidating the number of different operating companies as Crowley plans to do, the management team can identify businesses that will benefit from economies of scope & scale, allowing some of the lower-tier machine shops to contribute excess capacity towards supplying internal demand.
Outside of improving profitability, Triumph has identified better working capital management as a priority. Triumph currently lags far behind peers in terms of working capital, and has a large amount of cash tied up on the balance sheet. Unsurprisingly, the biggest source of Triumph’s problems is inventory. Triumph currently has about $1.34bn tied up as inventory on the balance sheet (equivalent to ~75% of the market cap). Another area where Triumph lags, but to a lesser degree, is accounts payable days. Through better leveraging size and buying power, Triumph can not only negotiate better prices, but better terms of repayment and increases accounts payable days. Bringing inventory days in-line with peers would lead to ~$300m of cash being released form the balance sheet, while brining accounts payable days in-line would release an additional $40m. Together, that is equivalent to 30% of the market cap, and 12% of the total enterprise value.
(Source: Author Calculations using Company filings)
Cost Rationalization – Manufacturing Footprint: Looking at Triumph’s manufacturing footprint, they are currently operating across 73 different facilities and ~14.5m square feet. Looking at various KPIs, Triumph underperforms peers on measures of Revenue, Gross Profit, and EBITDA per square foot for their Aerospace Structures, Precision Components, and Integrated Systems segments.
(Triumph re-formatted their operating segments in 2016. Prior to the reorganization, they had three segments, in which Precision Components / Aerospace Structures were grouped together. For ease of comparison they are grouped together through the period).
(Source: Company filings. Structures/Precision Comps Peer Group includes: Spirit Aerosystems, CPI Aerostructures, Ducommun, Hexcel, LMI Aerospace, Senior PLC. Integrated Systems Peer Group includes: Honeywell, Circor, Rockwell Collins, TransDigm, Moog, Megitt)
Triumph’s two worst divisions, Aerospace Structures and Precision Components, have actually held up well from a profitability standpoint relative to peers, with the exception of 2016 in which Triumph took a large impairment. However these numbers are somewhat warped as other structures players have had their own hurdles to overcome (such as Spirit with the 787 development program). Given the sometimes bumpy and difficult accounting behind aerostructures, the key metric to look at is revenue per square foot – where Triumph largely lags and generates under 60% of the sales per square foot that their peers do. Meanwhile, the Integrated Systems segment performs better from a revenue standpoint versus peers than it does from a Gross Profit / EBITDA standpoint. Part of this can be attributed to the fact that Triumph doesn’t have as much proprietary content (that earns 60%+ EBITDA margins in the aftermarket) as peers such as TransDigm.
The current plan to optimize the manufacturing footprint involves using the consolidation of the operating companies as an opportunity to eliminate unneeded facilities, and shift production to more economical areas. To quantify this, Triumph wants to cut the number of facilities from 73 to 60 in a “first wave of consolidations”, and address capacity underutilization by reducing the total square footage by ~15%. In his first 9 months, Crowley already eliminated 5 facilities representing 500k square feet, and has identified more locations for reductions. Triumph could shrink their footprint by an even greater amount than the planned 15%, especially if Boeing fully winds down the 747 program. The 2.1m square feet that the 747 is currently produced out of is alone equivalent to 15% of the total company’s square footage.
Cost Rationalization – Headcount: Along with reducing the number of operating companies, locations, and square footage, it is natural to reduce headcount, or else you are left with too many cooks in a smaller kitchen.
(Source: Company filings.)
Relative to peers, Triumph continues to underperform in just about every metric. Triumph can work to reduce the denominator (# of employees) as part of Crowley’s plan to shutter various locations and merge businesses together, eliminating redundant roles. Triumph is well on the way to its goal, with an 8% reduction in workforce being implemented in FY’17. Triumph can work to address the numerator (Revenue), by returning the business to growing organically (see below). This would lead to magnified improvements in Gross Profit and EBITDA per employee due to the high amount of operating leverage in the business.
Overall, Triumph is well on the way to its goal of achieving $300m of cost savings. So far, 5 non-core operating companies have been divested or put up for sale, 5 facilities have been closed, and overall headcount has been reduced by ~8%. This has translated to Adjusted EBITDA margins of ~14% through Q3 2017, a large improvement from the 12% margins in 2015, and 0% margins in 2016. Not only has the operating improvement been shown through increased profitability, but also through better working capital management. Triumph’s cash conversion cycle came down from ~196 days in the first nine months of FY 2016 to ~168 days in the first nine months of FY 2017.
Return to Growth: Triumph has experienced a substantial decline in sales over the past two years, which has led to negative operating leverage and depressed profitability. The decline in top-line can be attributed to two main factors. First is the production rate cuts on the 747, TGI’s largest program. Over the past 3 years, production rates have moved from 2 per month to 0.5 in FQ3 2016. With an estimated shipset value of ~$25m, the production rate cuts were extremely impactful, and led to a loss of ~$450m in sales per year. The second reason for the decline in sales was simply poor operating performance. At the time Crowley assumed his role, Triumph was in ‘red’ territory on 42 programs, and in ‘yellow’ territory on 72 programs, where TGI wasn’t meeting customer requirements, or was close to falling behind. TGI had numerous quality, cost, and on-time issues which led the organization as a whole to be placed on ‘no-bid lists’ at major customers. The inability to win new content, combined with declining production rates on the 747 (and 767/777 to a lesser extent) have created large headwinds.
Looking ahead, TGI will be lapping the latest 747 production rate cut in late 2017, leading that program to no longer be a year-over-year headwind to sales growth for the company. Also, Crowley has already improved operating performance to the point where TGI has been removed from all no-bid lists, allowing them to compete for new content. Book-to-Bill has averaged 0.8 since the start of FY’16, but has recently move over 1.0x for the first time in years. TGI’s two development programs will also provide organic growth opportunities in the near-term. With both the Bombardier Global and Embraer E-Jet E2 set to enter into service in mid to late 2018, TGI should benefit from a production ramp in 2018-2019. The additional benefit of a full production ramp in these two programs will be the release of cash from the balance sheet that has been tied up in inventory, specifically with the E-Jet E2 program (as Triumph wrote down the majority of their capitalized pre-production costs in inventory for the Bombardier Global due to delays/cost overruns).
Outside of the Aerospace structures portion of the business, Triumph is positioned well to benefit from future production rate increases in the narrow-body market. With the A320/A321 and 737 as the two largest programs in Integrated Systems (which is the most profitable segment of the business), Triumph should benefit as production rates increase to 57 and 60 per month in 2019 for the 737 and A320 respectively. TGI should benefit not only because of their existing content on the narrow-body programs, but due to the fact that rate increases give opportunities to bid on content. There are only a few sweet spots with big opportunities to get content on a program. The first occurs during the design & development phase, where the OEM chooses the structure providers, and the components and subsystem suppliers for each part of the aircraft. After 10-20 years, the OEM will typically launch a derivative aircraft, that could either be a clean sheet (practically brand new), or just a re-engine (737 MAX/A320neo). The third spot to win content is on major production ramps, as current suppliers may not have the capacity or willingness to ramp alongside the OEM, and will outsource a portion of the production to another supplier. As rates ramp on the 737 and A320, there should be an opportunity for TGI to bid for content on the programs.
Potential Business Jet Turnaround: Business jets make up about 20% of TGI’s sales, and have been in the midst of a down cycle since the financial crisis. While many attribute the tough business jet environment to corporate cost cutting, and emerging market weakness from softer commodity prices, this hasn’t been the case. The big boost to corporate net profits since the crisis has been lower debt servicing costs, and EM countries only account for 6-8% of total business jet sales. The biggest issue with demand was the massive overproduction from 2006-2010. Now as production has fallen off since the crisis, supply and demand is almost back into balance, and may even shift to under supply soon. This can be seen especially on the higher end of the market in super mid-size and ultra-long range (ULR) jets, where the majority of Triumph’s business jet exposure resides. A perfect example of this is the Gulfstream G650. The plane has a 3 year waiting list, and used jets are selling for premiums over brand new versions.
Triumph’s major business jet programs include the Gulfstream G280 (Super Mid-size), G450/G500 (Super Large), G550/G600/G650-ER, and Bombardier Global 7000/8000 (Ultra-Long Range). It’s possible that the new models being released in 2018/2019 (Gulfstream G500/600, Bombardier Global 7000/8000), combined with a normalization of supply & demand could stimulate a recovery in the business jet market, leading to an acceleration in Aerospace Structures sales growth.
(Source: Jetcraft Presentation)
Development Program Issues: A major hurdle for Triumph has been its largest development program, the Bombardier Global 7000/8000 wing. Bombardier has required multiple re-designs, and despite the fact the wing is a relatively cookie-cutter model and nothing too technologically advanced, it has led to numerous delays and unanticipated costs, leading Triumph to write down almost all of their capitalized pre-production costs and inventory. The redesigns, delayed entry into service, and missed milestone payments have led Triumph to sue Bombardier for ~$350m. Bombardier has stated they are working with Triumph to rectify the situation. The program is a major one for Bombardier, who is struggling in virtually all aspects of their business. Getting the Global 7000 launched and running at full production will do a lot to help their recovery. It is very unlikely that Bombardier will push Triumph out of the contract or even let Triumph pull out on their own – it would be too expensive and too much of a hurdle to certify a new supplier for the wing. The resulting pains and delays to the Global would likely be more harmful than simply negotiating with Triumph and paying them out all or a portion of what they’re demanding. A resolved suit could result in a material payout for Triumph, with the current amount demand equal to roughly 1/4th of the current market cap.
At the end of May, Triumph announced they came to a settlement with Bombardier for an undisclosed amount. This leaves further program delays as the only remaining risk for the development program.
End of Commercial Aerospace Cycle: Eight years following the financial crisis, the commercial aerospace industry is closer to a deceleration than a reacceleration. Order activity has slowed, though production rates are beginning to accelerate in narrow-bodies. The aggressive planned production rate ramps of 57 and 60 per month for the 737 and A320 respectively may indicate a peak, especially as production rates for other types of aircraft such as the 777, A350, and A380 are trending down.
Orders following the crisis were motivated primarily by higher oil prices (leading to a need for newer, more fuel efficient aircraft), and low interest rates (allowing for the financing of large purchases using attractively priced debt). Both of these factors have begun to trend in opposite directions from where they have been since the crisis. Orders peaked in 2014, and have come down in-line with deliveries alongside the decline in oil prices and the Fed’s first rate hike. Despite this, Boeing and Airbus still see material demand for the next two decades, with the slight majority of new purchases motivated by a need for replacement of old aircraft.
(Source: Boeing website)
Execution Issues on Restructuring: The biggest issue with any restructuring is execution. Triumph has previously demonstrated issues when executing moves such as facility consolidations, with the Jefferson Street to Red Oak transition being a prime example. Any bumps in the road while moving facilities or live programs could lead to quality or on-time delivery issues, putting programs back in ‘red’ territory and Triumph back on no-bid lists. Triumph may also incur additional charges associated with re-tooling facilities to accommodate new or shifted production.
Other execution risks include retaining experienced management personnel. A key element of improving the operations of the business involves centralization and consolidation, which will change the culture of autonomy and independence at the operating company level. Large changes in corporate culture or how the business runs could lead key middle management personnel to leave. It is unlikely any of the senior management would depart, as the majority were brought on as part of the CEO transition in 2016.
The last major issue will be motivating the production and line workers. 13% of Triumph’s workforce is unionized, and ~50% of their sales are derived from facilities with unionized employees. Triumph has had to deal with strikes before, with one occurring in May of 2016 at their Spokane Washington Facility. The employees at both Triumph’s Red Oak facility and Tulsa facility are currently not working under contract, and Triumph is engaged in negotiations with them. The Red Oak facility is especially important, as it serves as the manufacturing base for a few crucial programs such as the Bombardier Global and Embraer E2 E-Jet. Any large moves or headcount reductions may lead to backlash from the unionized workforce.
Production Rate Cuts on Key Programs: Production rate cuts, which would likely coincide with a decline in the commercial aerospace cycle, are an ever present risk. At the moment, TGI has been dealing with the numerous rate cuts on the 747, and will have to deal with future rate cuts on the 777 (going from 7 per month to 5). Rate cuts are an issue as it isn’t simply a loss of revenue (which isn’t always as great as at first glance, as normally OEMs increase prices to somewhat offset lower production rates), but it’s the issue of de-levering of fixed costs. TGI is very exposed to the wide-body portion of the market, with some of its major programs being the 777, 787, A330, A340, A350, and A380. Order activity has been substantially weaker than the narrow-body segment, leading to rate cuts in the 777, A380, and potential cuts in the A330/A350 depending on future order activity. The one resilient program has been the 787, which is potentially scaling up from 12/month to 14/month. On the narrow-body side, the risk isn’t so much production rate cuts as it is a risk that Boeing/Airbus don’t scale up their planned production rate increases as planned.
The Defense End Market: Triumph has material exposure to the military & defense market, making up ~24% of sales, and 33% of Integrated System’s sales. The majority of Triumph’s content comes from rotocraft, including the UH-60 Black Hawk, V-22 Osprey, CH-47 Chinook, and AH-65 Apache. Triumph also has substantial content on the C-130, which has been in continuous service for over 60 years, as well as the new KC-46A Tanker, which was converted from the 767. The major risk to defense sales is margin pressure. Defense sales are known for being somewhat sticky, but that comes at the expense of stronger pricing pressure than in the commercial end market. The other – but less likely – risk is that a significant change in the budget leads to a large production decline or outright cancellation of a program.
Appendix – Trusting the Accounting – Can you trust Triumph’s Historical EBITDA numbers?
The dangerous part of some of these aerostructure businesses with long-term contracts is the accounting becomes difficult with estimated costs, cumulative catch-ups, forward loss provisions, capitalized pre-production costs, inventory write-downs, and a whole bunch of other triggers/levers that can move around based on shifts in production rates. So in looking at a historical EBITDA number – you are making that you can trust Triumph’s accounting and cost estimation.
So all of the squishy accounting originates from the Aerospace Structures segments, where the majority of the chunkier long-term fixed price contracts are. Of course as production rates shift up/down, that causes changes in overhead per unit produced / potential re-negotiations with suppliers for different material amounts / labor, etc. So beginning by looking forward – if you were to try to identify “At risk” programs, i.e. where production rates are likely to be shifted down or have issues, they would be:
1) Collective Gulfstream Programs – incl. G280. G450, G500, G550, G600, G650ER (largest set of programs in the Aerospace Structures backlog)
2) Boeing 747 (3rd largest program in the Aerospace Structures backlog)
3) Bombardier Global 7000/8000 (5th largest program in the Aerospace Structures Backlog)
4) Boeing 777 (6th largest program in the Aerospace Structures backlog)
It’s been indicated that a rate cut in the 777 is likely, and a rate cut in the 747 would actually be a long-term benefit because TGI would hopefully be get rid of all the fixed costs associated with that program (which are huge – I’d estimate there’s $200m in costs, it includes 2 facilities over 2.1m square feet, ~1,000 people, plus materials, etc). The Global 7000/8000 could also be problematic if the entry-into-service gets delayed again, which has happened before and can easily happen again.
But if you were to look historically at the EBITDA number the company provides – I think it’s actually a reasonably good approximation. So the big two odd pieces are 1) acquired contract liabilities and 2) cumulative catch-ups (adjustments to cost estimations as the actual costs are realized).
The acquired contract liabilities are the result of a few of their acquisitions, namely the acquisition of Spirit’s G280/G650 wing program, and GE Aviation’s Hydraulic Actuation business. This gets accounted for in their Adjusted EBITDA number – the acquired contract liabilities are amortized as non-cash revenue. so if you were to look at GAAP EBIT/EBITDA, it would be overstated by the amount of the acquired contract liability (which can be substantial – it was >$100m the past two years. It should run at about ~$110m for the next few years.
(Source: Company filings)
The cumulative catch-ups is where it seems potential issues could happen. Below is a table that breaks down the impact of cumulative catch-ups on COGS. So the takeaway here is that if you include the impact of the 747-8 production cuts and the Bombardier Global delays, what you’re left with is that as a TGI has underestimated costs by an average of 411bps per year as a percentage of COGS ex. cumulative catch-ups. But, if you were to take out the impact of those two program adjustments, then TGI is only underestimating costs by ~76bps per year. So at the end of the day, it’s fair to say that Triumph has a history of consistently underestimating costs (CCU ex-special programs has only been positive in 2012), but that impact is relatively minor, 75bps per year. If you were to assume EBITDA margins of ~15%, you could assign a ~5% margin of error for their accounting methods.
Disclosure: I am/we are long TGI.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.