ALLIANT TECHSYSTEMS INC ATK
May 12, 2010 - 6:43pm EST by
ad188
2010 2011
Price: 78.00 EPS 7.33 (Mar'09) 9.04 (Mar'10)
Shares Out. (in M): 34 P/E 10.6x 8.6x
Market Cap (in $M): 2,652 P/FCF 8.5x 7.6x
Net Debt (in $M): 1,000 EBIT 0 0
TEV ($): 3,652 TEV/EBIT 7.6x (ex-charges) 6.6x (ex-charges)

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Description

Alliant Techsystems (ATK) was a 1990 spin of Honeywell (at $3/share). The company has grown organically and through acquisition. The major deals (over $170m in purchase price) have been Hercules ('95), Thiokol ('01), Blount Commercial Ammunition ('01), Mission Research ('04), and Blackhawk ('10). The company operates in 4 segments: Aerospace Systems, Armament Systems, Missile Products, and Security/Sporting (these segments are brand new- previously the company had three segments). We see this re-organization as a positive as it separates ATK's fast-growing Security/Sporting division (commercial business).
Aerospace Systems is ATK's space business (solid rocket motors for the Space Shuttle, Constellation program, other equipment) and their aerospace structures business (composites for aircraft). In FY'10 (Mar), this business did $1.6b in revenue and $170m in EBIT (31% of total company EBIT).  In the solid rocket business, ATK has 90% of the total U.S. wide-diameter solid rocket capacity (Aerojet is the other 10%). ATK does solid rocket motors for the Space Shuttle, the Constellation, the Minuteman III, Trident II, and some commercial rockets. This is a key strategic asset for the U.S.  For their solid rocket business, ATK is operating at only 35% of their total capacity (the business is cost-plus; therefore they can make money at very low capacity utilization). Their other space equipment includes: solar arrays and solar panel substrates, instrument support structures, titanium propellant tanks, radio frequency antenna reflectors/antennas, composite bus structures, towers, and subsystems that house flight systems for satellites. Their aircraft composite business is lightweight, high-strength composite structures on aircraft. Commercial aircraft structures include fan containment cases for the General Electric GEnx aircraft engine, aft fan cases for the Rolls Royce Trent XWB engine, and stringers and frames for a new commercial aircraft program. Military aircraft structures include components for the F-22 Raptor, an extensive range of external skins and components for the F-35 Joint Strike Fighter (they have current F-35 content of $1.8m per plane).
Armament Systems is ATK's DoD bullets, guns, and precision munitions businesses.  In FY'10 (Mar), this business did $1.7b in revenue and $154m in EBIT (28% of total company EBIT). ATK manufactures small-caliber training and tactical ammunition rounds at the Lake City Army Ammunition Plant in Independence, Missouri, where production totaled approximately 1.4 billion rounds in fiscal year 2009. The Lake City contract represented approximately 12% of ATK's total fiscal 2009 sales. ATK took over operation of this facility on April 1, 2000 and is responsible for the operation and management. ATK has reached agreement with the U.S. Army on a four-year supply contract as the primary supplier of small-caliber ammunition to the Department of Defense. Production on the new contract is expected to continue into fiscal 2014. 95% of bullets are used in training- so this is not a business that will collapse when we pull out of the Middle East! ATK also has medium-caliber chain-gun systems that provides armament solutions for U.S. and allied combat vehicles, helicopters, and naval vessels. They have supplied more than 15,000 medium-caliber gun systems to the U.S. military and 20 allied nations, including Poland, Finland, Denmark, the Netherlands, Switzerland, Norway, and the Czech Republic. New products include the lightweight 25mm chain gun.  ATK is the only North American supplier of military-specification nitrocellulose used in all small, medium, and large-caliber propellant, and rocket motors. ATK is the only supplier of TNT to the U.S. DoD.
Missile Products is ATK's tactical rockets, missile components, and special mission aircraft businesses. In FY'10 this business did $760m in revenue and $86m in EBIT (16% of total EBIT). This business is ATK's smallest in terms of EBIT and a bit of a mismash.
Security/Sporting is ATK's commercial bullet business (both private citizen and law enforcement) and their sporting accessories business. In FY'10, this business did $761m in revenues and $108m in EBIT (19% of total EBIT).  This business has been ATK's fastest growing: EBIT has tripled over the last 2 years (acquisitions have helped).  ATK has a number of important bullet brands: Federal Premium®, Fusion®, CCI®, Speer®, Blazer® and Estate Cartridge®. ATK has 35-38% market share in the commercial ammunition business in the U.S., Winchester (owned by Olin) has low 30%'s market share, and Remington (owned by Cerberus) has mid-teens market share.  Winchester and Remington have been losing share to ATK in commercial for a number of years due to ATK's better merchandising (ATK offers different brands through different channels) and ATK's excess capacity at Lake City and elsewhere.  Additionally, ATK's competitors are not well-positioned to re-take market share: Winchester is dominated by Olin's very capital-intensive and volatile chlor-alkali business and Remington is being capital-starved by Cerberus.  
Positives:
1. Valuation: 6.6x FY'10 (Mar) EBIT and 5.6x FY'10 (Mar) EBITDA. The company should do $300-325m in FCF in FY'11, which is a +12% FCY (on the equity, 9% FCY on the EV). The last time the company was 5.5x EBITDA was in the middle of 1997, when the company was only 20% of its current size (more importantly, the stock also offered very good forward returns from the middle of 1997).
2. Good returns on capital. ATK's pre-tax return on capital is 25% (including goodwill). Capex/revenue is 2.5%. 40% of ATK's square footage is GOCO ("government owned contractor operated"). The Lake City plant is government-owned: ATK just staffs the facility and skims the EBIT from the contract. The U.S. government has invested $4b into Lake City and ATK gets to earn $50m in EBIT annually with very little capital employed.
3. Great FCF. ATK generates a ton of FCF. In FY'10 they did $494m in CFO (before a $300m pension payment). Their cash flow statement reflects the $300m payment and even with the huge pension payment, they still generated FCF. FY'10, CFO was $194 (post-pension payment) and capex was $143m- leaving $50m in FCF.
4. Well-diversified business limits risk of DoD budget crash. Only 50% of the business is DoD, and 50% of this DoD business is armaments (95% of bullets are for training). NASA is 20% of the business. Foreign sales are 8%. Commercial is 18%. ATK's diversified business mix also makes it more attractive to potential acquirers in the case of a DoD budget crash.
5. ATK invests 2% of revenue in R&D, but the government invests 19% of ATK's revenue in government funded-R&D. ATK clearly benefits from the massive government investment in R&D. They can use the government-purchased know-how across the enterprise and into their commercial businesses.
6. ATK has gotten more efficient: over the last decade sales (and EBIT) per employee have gone from $178k ($17k) to $241k ($26k).
Why is the stock trading for 6.6x FY'10 (Mar) EBIT and 5.6x FY'10 (Mar) EBITDA?
1. Obama wants to cancel the Constellation program, which is the follow-on program to the Space Shuttle. This is the biggest issue surrounding the stock. In FY'11, ATK will do roughly $500m in at-risk Space revenue ($100m in Space Shuttle and $400m on the Constellation program).  The $100m in Space Shuttle is gone in FY'12- leaving the Constellation as the major support of the large-diameter solid rocket business. ATK builds the Ares solid rocket for the Constellation program (ATK's $400m of Constellation revenue is all Ares). Obama wants to cancel the program of record in order to help fund commercial space operations.  This radical new direction has stirred up quite a duststorm as Obama's plan will cut NASA out of the manned space business.  The plan is so radical that Obama has already had to retreat from the across the board program cancellation by letting Lockheed Martin keep the Orion capsule (part of Constellation). The next pushback was on the Senate side, with Senate Budget Committee Chair Kent Conrad adding $1b to the budget to fund an Ares bridge to keep the industrial base alive.  Kent Conrad: "In our classified discussions with respect to this initiative (money for ATK's wide-diameter solid rocket), I would say to my colleagues: this is absolutely essential for the national security that this go forward and I think every member of this committee understands what I am talking about."  This is a key strategic asset for the U.S.  We will see lots of back and forth over the next 8-12 months. At a budget hearing a month ago, Senator Barbara Mikulski, Chair of the Senate Appropriations Commerce, Justice, Science, Related Agencies Subcommittee, commented: "Are we going to be paying down one set of contracts to close them out and then paying to start new contracts?"  We think ATK's solid rocket motor business is a key U.S. asset and will be maintained at the $400m annual revenue level (what they have gotten out of NASA for decades).
2. Pension. ATK has a large DB pension. In FY'09 (Mar): $2.0b PBO and $1.4b in assets. ATK contributed $300m to the pension in FY'10, and that, with the help of asset returns should cut the pension hole a fair amount. ATK gets reimbursed for their pension contributions as pension is an allowable cost under government contracting. Employees hired after January 2007 get only the DC plan. FAS pension accounting swings GAAP EPS quite a lot, but cash is cash and ATK gets their money back from the customer for the pension expense.
3. ATK's commercial bullet business is operating at a peak. This is true- the US commercial bullet has boomed on the back of fears that the Administration may try to limit gun/bullet sales and overall economic and personal security anxiety. If you take out $250m of law enforcement ammunition and $200m of accessories- it leaves about $450m in private citizen ammunition, which is 10% of ATK's revenue. This business can fall a lot and it is not really that material.
4. ATK took a total of $146m of goodwill and trade name charges in FY'09 and FY'10. We see these non-cash charges as insignificant versus the combined $1000m in FY'09 and FY'10 EBIT.

Catalyst

Catalysts:
1. New CEO. The new CEO is Mark DeYoung, who ran their bullet business very successfully for a number of years. The appointment of DeYoung is a clear break from the past as the prior two CEO's were ex-Navy Admirals (Paul David Miller '99-'03, Daniel Murphy Jr. '03-'09). DeYoung pledges to be much more operationally and ROIC focused than the prior CEO who was growth-obsessed.  One of DeYoung's first tangible actions was to cut capex from $143m in FY'10(Mar) to $120m in FY'11(Mar). 
2. Significant pension contributions were made in FY'10. The company made $300m in pension contributions in FY'10 and going forward they will be able to recover that cash outlay on the basis of CAS (cost accounting standards- the DoD's method for contract management). With the pension issue out of the way, ATK can move to reward their patient shareholders (buyback,  dividend).
3. Balance sheet has been improving for years. Net debt was $1.5b in FY'07 versus $1.0b in FY'10. Over that period, EBITDA grew from $416m to $653m. There is a lot of de-leveraging that has gone on and now is a good time for the patient equity holders to be rewarded.
4. Possibility of significant stock buyback or dividend initiation. The company has not repurchased stock significantly since the FY'05-FY'07 timeframe. At the current valuation, it makes a ton of sense. A large repurchase is absolutely compelling at 6.6x trailing EBIT. The company does not pay a dividend because they always thought of themselves as a growth company and they wanted to keep the FCF to use for acquisitions.  They should be doing a large buyback and a dividend initiation. We think the company will see increased pressure to do something intelligent for shareholders.
5. Possibility of sector M&A or an LBO. Over the last two decades, there has been in excess of $100b in aerospace and defense sector M&A (primarily cash take-outs) at a weighted-average price of 1.2x sales and 11.4x trailing EBITDA. ATK trades for .76x sales and 5.6x trailing EBITDA. On the LBO front, the deal can be done fairly easily at $100/share level with $1b of newco equity and $3.5b of newco debt at 9%. Maintenance capex is only $60m.  On March 2010, ATK named Tig Krekel, who is the Vice Chairman of J.F. Lehman (a P.E. firm), to the Board of Directors.
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    Description

    Alliant Techsystems (ATK) was a 1990 spin of Honeywell (at $3/share). The company has grown organically and through acquisition. The major deals (over $170m in purchase price) have been Hercules ('95), Thiokol ('01), Blount Commercial Ammunition ('01), Mission Research ('04), and Blackhawk ('10). The company operates in 4 segments: Aerospace Systems, Armament Systems, Missile Products, and Security/Sporting (these segments are brand new- previously the company had three segments). We see this re-organization as a positive as it separates ATK's fast-growing Security/Sporting division (commercial business).
    Aerospace Systems is ATK's space business (solid rocket motors for the Space Shuttle, Constellation program, other equipment) and their aerospace structures business (composites for aircraft). In FY'10 (Mar), this business did $1.6b in revenue and $170m in EBIT (31% of total company EBIT).  In the solid rocket business, ATK has 90% of the total U.S. wide-diameter solid rocket capacity (Aerojet is the other 10%). ATK does solid rocket motors for the Space Shuttle, the Constellation, the Minuteman III, Trident II, and some commercial rockets. This is a key strategic asset for the U.S.  For their solid rocket business, ATK is operating at only 35% of their total capacity (the business is cost-plus; therefore they can make money at very low capacity utilization). Their other space equipment includes: solar arrays and solar panel substrates, instrument support structures, titanium propellant tanks, radio frequency antenna reflectors/antennas, composite bus structures, towers, and subsystems that house flight systems for satellites. Their aircraft composite business is lightweight, high-strength composite structures on aircraft. Commercial aircraft structures include fan containment cases for the General Electric GEnx aircraft engine, aft fan cases for the Rolls Royce Trent XWB engine, and stringers and frames for a new commercial aircraft program. Military aircraft structures include components for the F-22 Raptor, an extensive range of external skins and components for the F-35 Joint Strike Fighter (they have current F-35 content of $1.8m per plane).
    Armament Systems is ATK's DoD bullets, guns, and precision munitions businesses.  In FY'10 (Mar), this business did $1.7b in revenue and $154m in EBIT (28% of total company EBIT). ATK manufactures small-caliber training and tactical ammunition rounds at the Lake City Army Ammunition Plant in Independence, Missouri, where production totaled approximately 1.4 billion rounds in fiscal year 2009. The Lake City contract represented approximately 12% of ATK's total fiscal 2009 sales. ATK took over operation of this facility on April 1, 2000 and is responsible for the operation and management. ATK has reached agreement with the U.S. Army on a four-year supply contract as the primary supplier of small-caliber ammunition to the Department of Defense. Production on the new contract is expected to continue into fiscal 2014. 95% of bullets are used in training- so this is not a business that will collapse when we pull out of the Middle East! ATK also has medium-caliber chain-gun systems that provides armament solutions for U.S. and allied combat vehicles, helicopters, and naval vessels. They have supplied more than 15,000 medium-caliber gun systems to the U.S. military and 20 allied nations, including Poland, Finland, Denmark, the Netherlands, Switzerland, Norway, and the Czech Republic. New products include the lightweight 25mm chain gun.  ATK is the only North American supplier of military-specification nitrocellulose used in all small, medium, and large-caliber propellant, and rocket motors. ATK is the only supplier of TNT to the U.S. DoD.
    Missile Products is ATK's tactical rockets, missile components, and special mission aircraft businesses. In FY'10 this business did $760m in revenue and $86m in EBIT (16% of total EBIT). This business is ATK's smallest in terms of EBIT and a bit of a mismash.
    Security/Sporting is ATK's commercial bullet business (both private citizen and law enforcement) and their sporting accessories business. In FY'10, this business did $761m in revenues and $108m in EBIT (19% of total EBIT).  This business has been ATK's fastest growing: EBIT has tripled over the last 2 years (acquisitions have helped).  ATK has a number of important bullet brands: Federal Premium®, Fusion®, CCI®, Speer®, Blazer® and Estate Cartridge®. ATK has 35-38% market share in the commercial ammunition business in the U.S., Winchester (owned by Olin) has low 30%'s market share, and Remington (owned by Cerberus) has mid-teens market share.  Winchester and Remington have been losing share to ATK in commercial for a number of years due to ATK's better merchandising (ATK offers different brands through different channels) and ATK's excess capacity at Lake City and elsewhere.  Additionally, ATK's competitors are not well-positioned to re-take market share: Winchester is dominated by Olin's very capital-intensive and volatile chlor-alkali business and Remington is being capital-starved by Cerberus.  
    Positives:
    1. Valuation: 6.6x FY'10 (Mar) EBIT and 5.6x FY'10 (Mar) EBITDA. The company should do $300-325m in FCF in FY'11, which is a +12% FCY (on the equity, 9% FCY on the EV). The last time the company was 5.5x EBITDA was in the middle of 1997, when the company was only 20% of its current size (more importantly, the stock also offered very good forward returns from the middle of 1997).
    2. Good returns on capital. ATK's pre-tax return on capital is 25% (including goodwill). Capex/revenue is 2.5%. 40% of ATK's square footage is GOCO ("government owned contractor operated"). The Lake City plant is government-owned: ATK just staffs the facility and skims the EBIT from the contract. The U.S. government has invested $4b into Lake City and ATK gets to earn $50m in EBIT annually with very little capital employed.
    3. Great FCF. ATK generates a ton of FCF. In FY'10 they did $494m in CFO (before a $300m pension payment). Their cash flow statement reflects the $300m payment and even with the huge pension payment, they still generated FCF. FY'10, CFO was $194 (post-pension payment) and capex was $143m- leaving $50m in FCF.
    4. Well-diversified business limits risk of DoD budget crash. Only 50% of the business is DoD, and 50% of this DoD business is armaments (95% of bullets are for training). NASA is 20% of the business. Foreign sales are 8%. Commercial is 18%. ATK's diversified business mix also makes it more attractive to potential acquirers in the case of a DoD budget crash.
    5. ATK invests 2% of revenue in R&D, but the government invests 19% of ATK's revenue in government funded-R&D. ATK clearly benefits from the massive government investment in R&D. They can use the government-purchased know-how across the enterprise and into their commercial businesses.
    6. ATK has gotten more efficient: over the last decade sales (and EBIT) per employee have gone from $178k ($17k) to $241k ($26k).
    Why is the stock trading for 6.6x FY'10 (Mar) EBIT and 5.6x FY'10 (Mar) EBITDA?
    1. Obama wants to cancel the Constellation program, which is the follow-on program to the Space Shuttle. This is the biggest issue surrounding the stock. In FY'11, ATK will do roughly $500m in at-risk Space revenue ($100m in Space Shuttle and $400m on the Constellation program).  The $100m in Space Shuttle is gone in FY'12- leaving the Constellation as the major support of the large-diameter solid rocket business. ATK builds the Ares solid rocket for the Constellation program (ATK's $400m of Constellation revenue is all Ares). Obama wants to cancel the program of record in order to help fund commercial space operations.  This radical new direction has stirred up quite a duststorm as Obama's plan will cut NASA out of the manned space business.  The plan is so radical that Obama has already had to retreat from the across the board program cancellation by letting Lockheed Martin keep the Orion capsule (part of Constellation). The next pushback was on the Senate side, with Senate Budget Committee Chair Kent Conrad adding $1b to the budget to fund an Ares bridge to keep the industrial base alive.  Kent Conrad: "In our classified discussions with respect to this initiative (money for ATK's wide-diameter solid rocket), I would say to my colleagues: this is absolutely essential for the national security that this go forward and I think every member of this committee understands what I am talking about."  This is a key strategic asset for the U.S.  We will see lots of back and forth over the next 8-12 months. At a budget hearing a month ago, Senator Barbara Mikulski, Chair of the Senate Appropriations Commerce, Justice, Science, Related Agencies Subcommittee, commented: "Are we going to be paying down one set of contracts to close them out and then paying to start new contracts?"  We think ATK's solid rocket motor business is a key U.S. asset and will be maintained at the $400m annual revenue level (what they have gotten out of NASA for decades).
    2. Pension. ATK has a large DB pension. In FY'09 (Mar): $2.0b PBO and $1.4b in assets. ATK contributed $300m to the pension in FY'10, and that, with the help of asset returns should cut the pension hole a fair amount. ATK gets reimbursed for their pension contributions as pension is an allowable cost under government contracting. Employees hired after January 2007 get only the DC plan. FAS pension accounting swings GAAP EPS quite a lot, but cash is cash and ATK gets their money back from the customer for the pension expense.
    3. ATK's commercial bullet business is operating at a peak. This is true- the US commercial bullet has boomed on the back of fears that the Administration may try to limit gun/bullet sales and overall economic and personal security anxiety. If you take out $250m of law enforcement ammunition and $200m of accessories- it leaves about $450m in private citizen ammunition, which is 10% of ATK's revenue. This business can fall a lot and it is not really that material.
    4. ATK took a total of $146m of goodwill and trade name charges in FY'09 and FY'10. We see these non-cash charges as insignificant versus the combined $1000m in FY'09 and FY'10 EBIT.

    Catalyst

    Catalysts:
    1. New CEO. The new CEO is Mark DeYoung, who ran their bullet business very successfully for a number of years. The appointment of DeYoung is a clear break from the past as the prior two CEO's were ex-Navy Admirals (Paul David Miller '99-'03, Daniel Murphy Jr. '03-'09). DeYoung pledges to be much more operationally and ROIC focused than the prior CEO who was growth-obsessed.  One of DeYoung's first tangible actions was to cut capex from $143m in FY'10(Mar) to $120m in FY'11(Mar). 
    2. Significant pension contributions were made in FY'10. The company made $300m in pension contributions in FY'10 and going forward they will be able to recover that cash outlay on the basis of CAS (cost accounting standards- the DoD's method for contract management). With the pension issue out of the way, ATK can move to reward their patient shareholders (buyback,  dividend).
    3. Balance sheet has been improving for years. Net debt was $1.5b in FY'07 versus $1.0b in FY'10. Over that period, EBITDA grew from $416m to $653m. There is a lot of de-leveraging that has gone on and now is a good time for the patient equity holders to be rewarded.
    4. Possibility of significant stock buyback or dividend initiation. The company has not repurchased stock significantly since the FY'05-FY'07 timeframe. At the current valuation, it makes a ton of sense. A large repurchase is absolutely compelling at 6.6x trailing EBIT. The company does not pay a dividend because they always thought of themselves as a growth company and they wanted to keep the FCF to use for acquisitions.  They should be doing a large buyback and a dividend initiation. We think the company will see increased pressure to do something intelligent for shareholders.
    5. Possibility of sector M&A or an LBO. Over the last two decades, there has been in excess of $100b in aerospace and defense sector M&A (primarily cash take-outs) at a weighted-average price of 1.2x sales and 11.4x trailing EBITDA. ATK trades for .76x sales and 5.6x trailing EBITDA. On the LBO front, the deal can be done fairly easily at $100/share level with $1b of newco equity and $3.5b of newco debt at 9%. Maintenance capex is only $60m.  On March 2010, ATK named Tig Krekel, who is the Vice Chairman of J.F. Lehman (a P.E. firm), to the Board of Directors.

    Messages


    SubjectRE: thoughts...
    Entry06/01/2010 05:46 PM
    Memberad188
    1. the stock is cheap but not on trough numbers---- I think the valuation is a catalyst--- the business is very diversified--- no one has cut one cent yet of defense spending-- in fact it has been growing-- an initiation of a VAT would be very bullish for defense spending--- the defense budget can also be very well framed as a jobs issue...the jobs picture in the US is horrible
    2. I read that NDIA report.... their Lake City bullet business has boomed $625m in revenue and $54m in EBIT (10% of company total)... they also have medium caliber and TNT that has also gone up a lot...but the business is 6x trailing EBIT at $67/share... you can fade the business at 10% a year and EV/EBIT doesn't go above 6x...run your own numbers... I started the fade on FY'12 because FY'11 is locked... I am excluding the pension hole because the gov't will reimburse them for that. (15% annual revenue fade gets you to 7.5x EV/EBIT in 2016. For the fade I kept margins at 10% as contractors have been pretty good at managing to a 10% margin)
    3. Carlyle could very easily do this deal. BAE could also do it. Those are the most likely.
    I hope my comments helped.
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