It just never ends: Goldman puts a company on the Conviction Buy list and 3 days later the company issues either bonds or stocks. The most recent beneficiary of this highly ethical practice: Spirit Aerospace. This is a topic that has been beaten to death on Zero Hedge, so we will just present the facts.
Sequence of events:
September 17, SPR gets upgraded to the Goldman Conviction Buy list. Key points from the report:
Spirit a must own in Aerospace
Our CL Buy rating and 12-month view on Spirit is driven by:
- a structurally differentiated growth story, driven by an addressable market that
- is shifting from Boeing-only to all-of-Aerospace,
- more margin upside potential than peers, and valuation that leaves room for significant multiple expansion, despite Spirit being the only pure play in Aerospace (others have a Defense component and Aerospace stocks are more expensive than Defense stocks)
But we are also very positive on shares in the near-term as:
- the 737 production rate is likely to be cut less than expected, and we are raising production rates across the board, including on 737, which takes our estimates above consensus,
- program accounting and volume pricing agreements will cushion margins, and
- the cash flow overhang will begin to lift in 2010
Upward estimate revisions, 3Q earnings, new aircraft orders, and 787 first-flight all act as
potential positive near-term catalysts.
Gotta love that strong airline space. Well, if you ignore the facts that is. Ignore that IATA itself just raised it loss forecast for 2009 to $11 billion (on September 15th, two days before this report. Which explains much if not all: Goldman's fine analysts totally forget stuff that is out in the public domain for more than 5 minutes, they only remember the stuff that trickles through the less than public cracks). And just a brief reminder of what IATA CEO Giovani Bisignani noted: "Even with better volume, we don't see industry revenue returning to 2008 levels until 2012 or 2013 at the earliest. After the last major crisis following Sept. 11, 2001, it took roughly three-and-a-half years to recover those revenues and let's remember that Sept. 11 was not a global crisis, it was a shock." However, Jamie Baker was selling some hopium recently, and after all who is a better gauge of the industry: the industry itself or the leading JP Morgan airline analyst (lest we forget JPM has a few hundred quadrillion to match their interest rate swap book (we exaggerate on occasion) in inventory of EETCs and unsecured pieces of paper backing virtually every 737-800, 767, Embraer and what not in circulation).
Ironically, Spirit's CFO made a surprising departure which in turn followed the company's announcement of weak Q2 results. None other than Goldman in fact commented on this development:
This news comes as a surprise to us and potentially adds to investor concern in the near-term given that it comes on the heels of weak 2Q results that included several unusual issues, and that there is no clear, definitive replacement in place. We do not necessarily draw a connection between the issues in 2Q and this announcement, given that management changes on the G250 program in Tulsa were announced at the same time the reach forward loss (costs greater than revenue) on the program was announced, which was during 2Q earnings results.
Yet what are facts if not merely backward looking phenomena, when you have hope and unfounded promises to drive the future.
As a reference point here is what Bank Of America said about the company's 2nd quarter results, in a note titled "Credibility goes out the door, lowering PO to $15" dated July 31:
SPR reports very disappointing 2nd quarter
SPR reported $(0.06) EPS loss for 2Q09, a huge disappointment for a company that had shown execution finesse on the 787 program. The $93mn forward–loss on the G250 wing program cost $(0.46) per share and opened the doors to multiple concerns for investors, including: will the G650 and A350 programs experience similar difficulties?; can the company execute on non-Boeing programs?; and why was this not mentioned at the investor day on June 3rd, less than a month before the Q ended?
Now a “show-me” story
We believe SPR lost all credibility after today’s announcement and is now a “showme” story. Aside from concerns on other existing programs, we believe FCF could become a concern as cash balance dropped to $89mn, slightly above the $40-$50mn minimum required for daily operations, and customer advances of $813mn must still be repaid. Additionally, debt levels continue to increase, up 11% since 1Q09.
Lowering EPS through 2013
As a result of today’s earnings release we are updating our model to reflect lower margins in 2009 and the outyears. For 2009 our total operating margin dropped from 13.7% to 11.2% and includes a 2.7% margin in Wing Systems, down from our prior estimate of 11.1%. In all the outyears we also lowered our fuselage margins, assuming further 787 delays. As a result we lowered our 2009E EPS from $2.15 to $1.50, 2010E from $2.10 to $1.80, 2011E from $2.20 to $1.85, 2012E from $2.65 to $2.25 and 2013E from $3.05 to $2.45.
Lowering PO to $15 from $20
After these changes to our model, and accounting for the impact on cash flow from weaker earnings and poor cash flow conversion, we are lowering our PO to $15 from $20. This results from a 2.8% implied growth rate, a 12% cost of equity and a 10.8X continuing value multiple. We note this could prove conservative if the company proves it can execute on its programs, but SPR must first show tangible results.
Leave it to Goldman to do the dirty work for a name that Bank of America has signed off on.
So anyway, as no Goldman Conviction Buy is ever allowed to go to waste, the company today, a whopping three business days after the upgrade, announces it is issuing $300 million in 2017 Senior Notes in a private placement, although neither the 144A red nor the underwriter is announced. Granted the offering is "subject to market and other conditions" so expect a spattering of some more upgrades here and there. Zero Hedge has calls into the company's PR department to find out if this underwriter may end up being who everyone thinks it is.
As for where the Strong Buy upgrades will come from, one needs to look at the Use Of Proceeds on the notes: "intends to use the net proceeds from the offering to repay borrowings under its existing senior secured revolving credit facility without any reduction of the lenders’ commitment thereunder."
And who are the immediate beneficiaries of the $300 million revolver pay down: why everyone on Wall Street it appears. We present the most recent revolving agreement syndicate. The kitchen sink is suspiciously present, although the most happy will undoubtedly be joint-bookrunners Bank Of America, RBS and Bank of Nova Scotia who can get repaid at par on yet another potentially shaky investment.
In the current banana market, one should now fully expect at least 50 upgrades on the stock coming from all the banks on the list. Can't have market conditions turning unfavorable to yet another pump and dump that absolves what is virtually every bank in the world from doing a little friendly equity-for-debt swap, courtesy of a fully reasoned Conviction Buy recommendation.