Wesco Aircraft Is Bound To Fly

Wesco Aircraft (WAIR) is the No. 2 distributor and provider of supply chain management services to the global aerospace industry. You can read the long description here. The short one is that Wesco buys and sells small manufacturing parts (like those in the picture below) and chemicals. Also it provides services by taking on a customer inventory, and sending the appropriate parts in a JIT (just-in-time) basis. This way the customer frees up working capital and reduces expenses as they out-source a complex and expensive part of their procurement process.

In 2014 Wesco acquired Haas, which supplies aerospace companies with chemicals needed for their production (mainly gases). Haas was an opportunity for Wesco to expand its product offerings and become an even more integrated part of its customers' manufacturing process. However after the acquisition things went somewhat awry.

After 2 years of declining revenue, more than $500mil write-offs and warnings by its customers that performance is falling below acceptable levels, Wesco fired its CEO, hired outside consultants and finally is turning things around. Check the excerpts below to get a feel of the turn.

Q2 2017 earnings call:

Adam Joseph Palmer - Wesco Aircraft Holdings, Inc.

[��] While unusual, the board thought it was appropriate to say a few words before turning the call over to management to discuss the quarter. As Wesco has already announced, on April 26, Todd Renehan was appointed as Chief Executive Officer and Alex Murray as President and Chief Operating Officer.

Over the past several quarters, we've witnessed stagnant to declining sales and gross margins despite a number of significant contract wins and strong renewal activity. As the board, we are committed to delivering shareholder value, and we believe that Todd and Alex are uniquely capable of addressing our current challenges and returning the company to a path of consistent growth and increased profitability. [��]

Todd Renehan - Wesco Aircraft Holdings, Inc. CEO

Thanks, Adam. I'd like to start by saying that while we're disappointed with our recent performance, Alex and I are honored to have this opportunity to lead Wesco. [��] While Wesco has made progress in a number of areas, including our internal processes and new business wins and contract renewals, it's clear that our recent performance has fallen short of expectations.

The company has undergone a lot of change over the past two years. While a number of these changes were needed, in hindsight we tried to change too much too fast. This has taken our focus off the customer and impacted our business.

In a nutshell, we believe the company has become too inwardly focused, which has impacted relationships with customers and at times led to decisions which made sense in the short term, but may have had other adverse consequences. This has muted the pace of new business wins and contributed to the decline in ad-hoc sales, while also pressuring gross margins. [��]

And I know, from my discussions with many of our customers, that they're ready to give us more work as we improve our performance. Wesco's performance rates are among the highest in the industry, but we do so much volume with these customers that a small hiccup can meaningfully impact their production, and by increasing our external focus, we believe we'll be able to improve beyond even our current standards.

Q1 2018 earnings call:

Todd Renehan - Wesco Aircraft Holdings, Inc. CEO

[��] As you might remember, last quarter we said that we were beginning to see signs of better operating performance as a result of our improvement plan initiatives. Now, I'm happy to see that these initiatives are also beginning to drive improved financial results. Of course, this is only one quarter and we have a lot more work to do, but I'm encouraged by our progress. [��]

[��] We continue to receive positive comments from customers regarding our performance improvement and the value that Wesco provides. I've spent time recently with a few of our major customers and heard firsthand many positive comments about the improvements we've made to service performance. We believe that the increase in ad-hoc sales in the first quarter in part reflects our improved performance, and it's consistent with the bookings trends we told you about last quarter. [��]

Les Sulewski - SunTrust Robinson Humphrey, Inc.

Hi. So I guess, first on the business assessment side. Can you just talk a little bit overall what color are you seeing? Is it the demand increasing, is it just you coming out of the penalty box, if you will? And just overall, some of the drivers driving the business at the moment.

Todd Renehan - Wesco Aircraft Holdings, Inc.

Yes, it's a little bit of both. We had good sales performance on a couple fronts. The chemical performance was stronger with a ramp up of military platforms, the hardware sales were a reflection of both new business and higher volumes, and the ad-hoc growth was driven by our better performance as well as some specific customer growth.

Wesco has stopped digging and is currently working to get out of the hole it put itself into. Sales are growing from new and existing clients and margins will follow soon enough as ad-hoc business increases. Despite these very good news though, the best news for Wesco come in disguise. Boeing (BA) announced that it will acquire KLX's (KLXI) aerospace division. Here is some select pieces from KLX's conference call.

Amin Khoury - KLX CEO

[��] As we announced in our press release earlier this morning, we have agreed to sell our ASG business to the Boeing Corporation in all-cash transaction with the sale of 100% of the shares of KLX Inc. KLX shareholders will receive $63 per share in cash for each KLX share and the Boeing Corporation will assume the net debt of KLX at the time of closing. This represents an aggregate purchase price for our ASG business of $4.25 billion, including the assumption of $995 million of net debt. This transaction values ASG at a multiple 15.7 times 2017 EBITDA and 14.3 times estimated 2018 adjusted EBITDA. [��]

[��] Tom Mccaffrey and I have agreed to continue on as the executive leadership of KLX Energy Services. I will become Chairman and the Chief Executive Officer of KLX Energy Services, while Tom will become Senior Vice President and Chief Financial Officer. [��]

While the first read of this deal is that Wesco will face an insurmountable foe in the form of Boeing, I believe otherwise. This deal is beneficial to Wesco in three significant ways:

1.It will drive new business to Wesco.

Many OEMs and airlines that compete with Boeing or have significant exposure to them will be looking for alternatives. This will be either to diversify their suppliers, or to avoid Boeing managing their hardware. Wesco being the No.2 is the obvious choice and since they have fixed their internal issues they are more than ready to benefit. Here are some relevant quotes from Wesco's Q2 2018 earnings call, a few days after the Boeing-KLX deal was announced.

Todd Renehan - Wesco Aircraft Holdings, Inc. CEO

[��]we are not losing share to KLX. As a matter of fact, over the past quarter we're taking share.[��]

[��] many of these OEMs compete with Boeing and will not want to do business with them. And it shouldn't be lost on folks that there's opportunity here for us. While we can't speak for our customers, it's clear that many of these OEMs would not be thrilled about the prospect of Boeing managing their hardware. [��]

[��] We believe that the airlines and the MRO shops like having the alternatives. And we expect that to help our growth. And we also believe that they want to control their own material base. We believe that this might put KLX in a position where they have to give Boeing priority to provide parts against an MRO. [��]

2. It has uncovered Wesco's cheapness.

Boeing bought KLX's ASG division at 14.3 times its 2018 estimated adj. EBITDA or 15.7 times its 2017 adj. EBITDA. Applying this valuation to Wesco itself would imply a price range of $11-$14.8 per share based on 2018 estimates and $12 - $16.3 based on 2019 estimates. Also, I would like to point out that Wesco's fiscal year ends on September. This means that as time passes the market, due to its forward looking nature, will be more likely to look at the second valuation range than the first.

3. Amin Khouri and Tom Mccaffrey leave KLX.

These two executives are market darlings and the driving force behind KLX's success. However, they will leave KLX with the energy division that will be spun-off to existing shareholders. Also, as an acquired company KLX will be subject to several changes as Boeing tries to implement its own vision and culture post-acquisition.

Therefore it is my opinion that KLX will be vulnerable to Wesco's attempts to take market share for quite some time.

Wrapping it up

Wesco announced along with its Q2 earnings an initiative called "Wesco 2020". It is essentially a gradual operations restructuring that will deliver permanent annual gains of $30mil pre-tax by 2020. This will start from fiscal 2019 and will deliver the full results within 18 to 24 months.

If successful, this initiative will add about $4-$5 of value per share over the next 2 years increasing the previous valuation ranges we discussed even more.

Wesco has been one of the most despised stocks over the last 3 years. The business however, has turned and there are strong signs that the company is seriously undervalued. Despite its recent run I believe it has a lot of upside yet especially if one is willing to wait 2-3 years.

Disclosure: I am/we are long WAIR.

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.