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John Engle
John Engle
Articles (406) 

Aerojet Rocketdyne Reaches for the Stars

Internal cost improvements and external market growth sent this rocket stock rocketing upward

September 09, 2019 | About:

Aerojet Rocketdyne Holdings Inc. (NYSE:AJRD), a relatively small aerospace and defense company specializing in rocket propulsion systems, has been soaring in recent years.

The company has worked diligently to improve profitability, while also positioning itself to reap the rewards of a rapidly expanding space industry. As a result, its stock has far outstripped the performance of both its industry and the stock market as a whole.

At first glance, such blistering stock performance might spook a dedicated value investor. However, Aerojet Rocketdyne deserves a second look. Indeed, it may well climb significantly higher into the financial firmament.

The rules of acquisition

Aerojet Rocketdyne was the result of a 2013 merger between two struggling rocket engine manufacturers, Aerojet and Rocketdyne. Aerojet’s parent company, GenCorp, bought Rocketdyne from Pratt & Whitney, a subsidiary of United Technologies Corp. (NYSE:UTX).

While bringing these two stragglers under the same roof was billed as a case of obvious synergy, observers were far from certain as to whether such a combination of resources would actually achieve the promised improvements to operating efficiency and industry competitiveness.

At first, things did not improve appreciably for Aerojet Rocketdyne. In fact, the company’s profit margins actually declined slightly for more than a year after the merger. However, since late 2014, profitability has steadily improved, as the promised operational synergies began to materialize. Cost management has proven particularly important, and is responsible for the lion’s share of improved profitability. One of the decisions the company made to that end was to move much of its workforce from high-cost California to much cheaper Arkansas.

The stock jumps to warp speed

Aerojet Rocketdyne has consistently lagged the rest of the aerospace and defense industry in terms of profit margins, but it has closed much of the gap during the past few years.

In 2013, the company reported gross margins of about 10%, less than half the industry average of 19.5%. As of Aug. 22, Aerojet Rocketdyne’s gross margins have improved to 16.3%, while the industry’s profitability has remained flat.

Aerojet Rocketdyne’s robust financial fortunes have sent its share price rocketing upward. Since the merger, its stock has risen by nearly 700%, blowing away the 280% gain to the aerospace and defense industry as a whole over the same period, and absolutely smoking the 150% gains in the S&P 500 index.

Space, the financial frontier

The space economy has been enjoying a bit of a renaissance in recent years, as corporations and governments alike have launched ever more, and ever more sophisticated, rockets and satellites into orbit.

At the same time, investors have warmed increasingly to the prospects for the space economy, which is poised to see tremendous growth over the next few decades. According to UBS, financial markets are only beginning to understand just how big the opportunity really is:

Mainstream financial markets are only just starting to awaken to the commercial and disruptive opportunities that space offers, as technology is starting to tear down the high entry barriers to access space. We forecast that the combination of declining space launch costs and advances in satellite technology will raise the value of the space economy from $340 billion currently to nearly $1 trillion over the next two decades.”

Where no president has gone before

While the commercial space industry is growing at a healthy clip, aerospace and rocketry companies still rely on government demand for their bread-and-butter business. Aerojet Rocketdyne CEO Eileen Drake observed last week that the industry has been bolstered by a level of federal buy-in not witnessed since the 1960s, Spacenews.com reported.

“The time is now," she said. "Most of us who have been in this business have never seen a time where we have the administration and Congress this focused both on space and on defense.”

The Trump administration, especially, has put space back on Washington’s policy agenda in a big way. Trump has promised a bold reassertion of American leadership in space; his reestablishment last month of the U.S. Space Command and the relaunch of the National Space Council in 2017 certainly suggest that the government’s newfound commitment to space is far from mere rhetoric.

Go long, and prosper?

How much more can Aerojet Rocketdyne hope to climb?

On Friday, the stock was down slightly, closing at $51.60 per share, translating to a market capitalization of just over $4 billion. With a price-earnings ratio of 24.33, Aerojet Rocketdyne is not too far out of alignment with the current aerospace and defense industry average of 24.01. However, the industry price-earnings ratio has been climbing for some time, having bottomed out at just over 9 during the Great Recession.

Aerojet Rocketdyne’s current share price can hardly be called a bargain by traditional value investing standards. But the company still has some room to improve its cost efficiencies, which could see it match that of the industry. Additionally, secular rocket industry growth should serve as a meaningful tailwind for all industry players, including Aerojet Rocketdyne.

Verdict

After years of market-beating performance, one might naturally question whether Aerojet Rocketdyne can offer investors any sort of bargain at this point. However, far from running on fumes, this rocketing rocket stock appears to have a couple more booster stages still primed to fire.

Disclosure: No positions.

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About the author:

John Engle
John Engle is president of Almington Capital - Merchant Bankers. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin and an MBA from the University of Oxford.

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