Backlog Up Bigly, Stock Down Biggerly.
Aerojet Rocketdyne (AJRD) stock has taken a drubbing of late. Down some 16% since the start of the year, despite a very strong start for the name in Q1, we confess to being rather puzzled as to this state of affairs. The company is inexpensively valued on fundamentals, has a large and growing backlog including a recent monster NASA contract, and is geared to a number of key growth themes across space and defense. Here we consider how Q2 numbers could play out.
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First up, two points you should bear in mind as you read this post. As a house we're at Buy on AJRD - subscribers can read our full Pro investment note here - if you're not yet a subscriber you can buy the Pro note on a standalone basis here. In addition, at the time this post was published, Cestrian Capital Research, Inc staff held long positions in the stock on a personal account basis.
This storied company has put in an exceptionally strong fundamental performance since the new CEO and CFO took the reins in 2015. Revenue growth has been positive every year since then, if hardly at an exciting rate, but the big story here has been improving gross and operating margins, and in particular, relentless cash generation. The business carried net leverage of 1.4x TTM EBITDA as at the end of 2016; by Q1 2020 it was in a net cash position to the tune of 0.8x TTM EBITDA. Still more impressively, net leverage through the pension obligations was 4.6x TTM EBITDA at the end of 2016 and was just 0.4x TTM EBITDA by Q1 2020. In the aerospace and defense sector that is highly unusual and speaks to the quality of financial management at AJRD.
The combination of weak revenue growth in Q1 (-3% vs Q1 2019), a sequential quarterly drop in backlog ($5.2bn in Q1 vs. $5.4bn in Q4 '19) and, oh yes, a global pandemic, sent the stock plunging during the second quarter. At the time of writing the stock is down 16% year to date, vs the S&P flat over the same period.
AJRD Stock Price Performance vs SPY, YTD 2020.
Q2 earnings are due in the coming weeks. We can't be more precise than that, because the company doesn't publish its earnings date ahead of time any more than it holds earnings calls or provides guidance. The company runs to a calendar year, so Q2 is the 1 April - 30 June quarter and we would expect a report sometime between late July and mid August. We'll provide detailed earnings analysis at that time.
Something to flag going into Q2 though is the huge $1.8bn NASA order that AJRD received during the quarter, for a production run of rocket engines destined for the upcoming SLS rocket. SLS is core to NASA's space exploration plans, so absent a major change of heart in Washington, this is a contract that we expect to proceed. As you would expect, that $1.8bn will roll into the income statement and indeed into the company bank account over a number of years; but it ought to roll into backlog in Q2. Now, as you can see from the numbers above, that ought to take backlog from $5.2bn in Q1 to $7.0bn in Q2 if there are no other changes. And whichever way you look at it, that step-up in revenue, earnings and cashflow coming down the pike ought to be worth something. So for this reason alone we are particularly fascinated to see how Q2 earnings play out, both in reality - ie. how did the company perform - and in the eyes of the market, ie. how will the stock respond. It ought to jump on the news - but in an environment where the big money has been chasing cloud stocks all quarter and everyone on Wall St. has officially forgotten that space is a thing - maybe it won't. We watch with great interest.
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