The aerospace and defense industry is characterized by frequent and often large mergers and acquisitions. One name that has recently made headlines in this regard is Aerojet Rocketdyne (ARJD), an aerospace and defense company known for rocket engines such as the RS-25, the RL10 used in the Centaur rocket stage of Atlas V and the RS-68, which is the largest hydrogen rocket engine ever flown. The company is also known for developing the Multi-Mission Radioisotope Thermoelectric Generator for the Mars Curiosity Rover and a second flight unit that is powering the Mars-based Perseverance Rover.
In addition to the space and defense business, the company also owns the real estate firm Easton Development Company, which owns over 12,000 acres of land near Sacramento, California. This was originally utilized for Aerojet's operations in testing and manufacturing dating back to the 1950s, but due to the evolution of the company and propulsion technology, roughly half of this land is now being developed for residential and commercial real estate.
Aerojet traces its origins to the General Tire and Rubber Company established in 1915, while Rocketdyne was created as a division of North American Aviation in 1955. The company currently has a market capitalization of $4.3 billion, and analysts expected it to generate $2.2 billion in revenues this year.
One might think a company with this many achievements doesn't need to be acquired, but Aerojet is trying to take advantage of higher market valuations to secure hefty payouts for its investors. Previously, it had a deal to be acquired by Lockheed Martin (LMT, Financial), which was struck down due to antitrust concerns. At a price-earnings ratio of 46.33, investors could be in for a valuation correction if a deal doesn't materialize.
Acquisition rumors
Aerojet's stock has been running hot lately as it tried to sell itself after its $4.4 billion to Lockheed Martin, but this was stopped by antitrust regulators in February. If the appeal concludes successfully, the deal could be completed by the end of this year, but there's no certainty of this.
In light of the Lockheed deal being struck down, Aerojet has been looking for a new suitor. Those rumored to be potential buyers include industrial conglomerate General Electric Co (GE, Financial), defense contractor L3Harris Technologies Inc. (LHX, Financial), aircraft manufacturer Textron Inc. (TXT, Financial) and private equity firm Veritas Capital.
However, Aerojet has said that if it doesn't get an attractive enough offer, it might decide not to sell itself. While this won't likely be detrimental to the company, as it stands on solid financial footing already, it could spell trouble for investors because the hopes for an acquisition at a premium price have kept the stock price overvalued, as shown in the GF Value chart below:
Financial review
So what would the company be worth without an acquisition? Let's start answering that by looking at the recent earnings report. The company recently reported its third-quarter results, which showed modest revenue growth of approximately 1.0% and declining operating income. Aerojet is experiencing short-term supply chain delays and other unusual operating costs. Net income declined to $36.7 million from $47.7 million in the prior-year period. Ebitda dropped to $75.7 million from $82.5 million a year ago. The company excludes post-retirement and pension benefits for its calculation of Ebitda.
Aerojet's CEO stated:
“Aerojet Rocketdyne delivered a solid quarter, with strong operating profit, improved cash flow and a healthy backlog that demonstrates our role as a preferred supplier. While we continue to experience certain short-term supply chain delays, notably on the RS-25 program, the actions we’re taking to mitigate those are showing results. As we look to the future, we are intently focused on investing in line with our nation’s defense and space priorities, driving improvements to increase our competitive edge and positioning Aerojet Rocketdyne for enhanced shareholder value creation.”
The company maintains a strong balance sheet with cash and equivalents of $334.5 million and total debt of $306.8 million. However, the company has $254 million in reserves for environmental remediation costs and a $223 million pension liability.
As of the end of the third quarter, the company's total remaining performance obligations (backlog) totaled $6.7 billion. The company expects to recognize approximately 34%, or $2.3 billion, of the backlog as sales over the next 12 months, an additional 25% in the following 12 months and 41% after that.
Valuation
Consensus analyst earnings per share estimates are $1.68 for 2022 and $2.02 for 2023. This gives us an elevated forward price-earnings ratio of 32 even for earnings that are more than a year out, which is largely related to a potential acquisition premium as well some unusual cost issues this year. The above-average forward enterprise-value-to-Ebitda ratio of 16 also reflects those issues.
The GuruFocus discounted cash flow calculator also reflects overvaluation, giving a fair value estimate of around $20 using a long-term growth rate projection of 10% and a discount rate of 10%.
The company does not pay a dividend at this time and is a modest repurchaser of its own share with only $4.7 million worth of shares bought back for the first nine months of 2022.
Guru trades
Gurus who have purchased or added their Aerojet Rocketdyne positions include Mario Gabelli (Trades, Portfolio) and First Eagle Investment (Trades, Portfolio). Gurus who have reduced or sold out of their positions include Joel Greenblatt (Trades, Portfolio) and Catherine Wood (Trades, Portfolio).
Conclusion
Overall, I believe Aerojet Rocketdyne is a high-quality company, but its current valuation hinges entirely on a hypothetical acquisition. If an attractive enough deal doesn’t come through in a near-mid term time frame, substantial downside potential is likely.
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