Ducommun: Management Expects Margin Expansion And Revenue Growth (NYSE:DCO)

Ducommun Incorporated (NYSE:DCO) is a company that provides manufacturing solutions for customers in the aerospace, defense, and industrial markets.

In terms of business segments, Ducommun has two core businesses, an electronic systems business that accounted for 57% of revenue in 2023 and a structural systems business that accounted for 43% of sales in the same year.

In terms of end markets, Ducommun has two key sectors, the defense sector, also known as the military and space sector, that accounted for around 53% of the company’s 2023 revenue, and the commercial aerospace sector that accounted for 41% of sales. Meanwhile, the industrial sector accounted for 6% in the same year.

In terms of the last 10 years, Ducommun stock has done relatively well although its shares have not increased much since 2019.

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In terms of growth, Ducommun’s adjusted EBITDA has not increased all that much from 2019 when the company had adjusted EBITDA of $92 million.

Since 2019, the company has had adjusted EBITDA of $88 million in 2020, $93 million in 2021, $95 million in 2022, and $102 million in 2023.

One reason for the slower growth in adjusted EBITDA has been the pandemic’s effect on commercial aerospace.

In terms of revenue by end markets, commercial aerospace accounted for $348.5 million of Ducommun’s revenue in 2019, $168.1 million in 2020, and $155.7 million in 2021 given the beginning of the pandemic.

With the recovery in demand and also M&A, commercial aerospace accounted for $247.5 million of Ducommun’s revenue in 2022 and $309.3 million in 2023.

So even with the recovery from 2020, Ducommun’s commercial aerospace end market revenue in 2023 is still lower than what it was in 2019.

On February 15, 2024, Ducommun reported 2023 results that showed growth from 2022. For the future, management is optimistic about adjusted EBITDA growth and on April 16, 2024, Ducommun’s board rejected an unsolicited, non-binding indication of interest from Albion River LLC offering $60 in cash per share given their view that the offer does not fully reflect the company’s long term growth initiatives.

2023

For 2023, Ducommun had net revenues of $757 million, adjusted EBITDA of $102 million, and 13.4% adjusted EBITDA margin.

That’s up from 2022’s revenue of $713 million, adjusted EBITDA of $94.7 million, and adjusted EBITDA margin of 13.3%.

In terms of end markets, Ducommun’s revenue from the military and space end market declined to $403.8 million in 2023 from $420.7 million in 2022. Sales from the commercial aerospace end market rose to $309.3 million in 2023, up from $247.5 million in 2022. Meanwhile, the company’s industrial end market sales declined slightly to $43.9 million in 2023 from $44.3 million in 2022.

In terms of backlog, Ducommun ended the year with a backlog of $994 million, up $30 million year over year. In terms of segments, the company’s military and space backlog rose $70 million year over year to $527 million and the commercial aerospace backlog declined around $21 million year over year to $429 million.

In terms of M&A, Ducommun completed the acquisition of BLR Aerospace in 2023 for $114.4 million, net of cash acquired.

To finance the purchase, Ducommun completed a public offering of 2.3 million of common stock in 2023, netting the company $85.1 million, and the company also ended the year with a net debt of $223 million, up from $202 million at the end of 2022 given M&A financing. Even with the increase in debt, Ducommun ended the year with a leverage ratio of 2.3, which is pretty decent.

My takeaway is that Ducommun continues to benefit from the recovery in the commercial aerospace end market while demand from the military and space end market was slightly softer than in 2022. While defense demand softened slightly, Ducommun’s military and space end market backlog nevertheless rose meaningfully and I expect the military and space end market to be a growth market in the long term. Meanwhile, management continues to expand with M&A.

Outlook

In terms of outlook, Ducommun management is optimistic about the growth ahead in terms of demand from the defense and commercial aerospace end markets.

In terms of the defense end market segment, Ducommun in April 2024 announced two awards totaling more than $50M in revenue for Raytheon radar systems, helping increase the company’s backlog.

Management is also optimistic about the commercial aerospace recovery as they believe record order bookings and anticipated growth in production rates at both Boeing and Airbus will continue to provide a tailwind.

Further in the future, Ducommun management has a Vision 2027 plan to transition to higher engineered product content and aftermarket revenues while continuing to build a portfolio of niche aerospace and defense businesses.

In terms of their 2027 outlook, management expects to achieve around $950 million to $1 billion in net revenues with around 18% adjusted EBITDA margin and around 13% adjusted operating income margin by 2027.

By 2027, management has a goal of growing Ducommun’s defense business revenue to around $525 million+ and commercial aerospace revenue to around $325 million+. Management also has an acquisition placeholder of around $75 million+ a year by 2027, indicating they will continue to do M&A in the future.

In terms of revenue, I think management will achieve their Vision 2027 goal of around $950 million to $1 billion by 2027 given the organic CAGR assumption of around 5% going forward isn’t particularly high as long as the commercial aerospace end market makes a full recovery.

In my view, however, the around 18% adjusted EBITDA margin goal might be tougher to achieve even though management believes they can get better margins with more scale from the defense business and greater demand from the commercial aerospace business if there is a full recovery.

While I think the defense business can grow to the anticipated around $525 million+ by 2027 given its historical growth trends, I think a full commercial aerospace recovery isn’t necessarily guaranteed given the sector is economically sensitive. As a result, the company might not generate the adjusted EBITDA that management expects in 2027.

To me, 18% is an optimistic number as the highest adjusted EBITDA margin Ducommun achieved was around 14% in 2020 in terms of the last 5 years. In terms of adjusted EBITDA margin, Ducommun achieved 13% in 2019, 14% in 2020, 14% in 2021, 13% in 2022, and 13% in 2023.

As such, I think an adjusted EBITDA of 15% by 2027 would be a more reasonable assumption that incorporates uncertainty in the commercial aerospace recovery and potential increases in competition. That being said, I think Ducommun can achieve the around 18% goal but that it would be more difficult.

M&A

In terms of M&A, Albion River LLC on April 8, 2024 offered to buy all outstanding shares of Ducommun for $60 in cash per share in an unsolicited, non-binding indication of interest.

On April 16, 2024, Ducommun’s board rejected the proposal, writing the proposal undervalues Ducommun and does not fully reflect the company’s long term growth initiatives.

Instead, the board thought management’s Vision 2027 strategy reflected a better long term value creation opportunity.

Risks

Management might make a bad acquisition which might not generate the type of EBITDA or growth that they expect.

Commercial aerospace is a cyclical industry where demand could decrease substantially due to economic or other reasons. During the beginning of the pandemic, for instance, Ducommun’s commercial aerospace sales fell from $348.5 million in 2019 to $168.1 million in 2020. If there is a substantial economic recession, Ducommun’s revenue and EBITDA might face headwinds given likely weaker orders for the commercial aerospace business.

Defense demand might not be as strong as expected. Although the defense industry has historically grown, sector defense spending could change depending on priorities, and unfavorable changes could mean softer demand.

Competition could be a headwind for margins. Ducommun competes in highly competitive markets that are also price sensitive, with some of the company’s larger competitors able to compete more effectively given greater capabilities. Given management wants to expand margins substantially, Ducommun could find it more difficult to achieve management goals given the competition.

Valuation

In terms of EPS estimates, analysts on average expect Ducommun to earn $2.90 for 2024, $3.68 for 2025, and $4.52 for 2026 according to Seeking Alpha. Given the estimates, the company would have a forward PE ratio of 18.39 for 2024, 14.49 for 2025, and 11.80 for 2026.

When incorporating debt, Ducommun has a forward EV/EBITDA ratio of 9.18, versus the sector median of 11.23 and its 5 year average of 9.07. Peer Astronics has a forward EV/EBITDA of 8.1.

Based on analyst estimates, Ducommun is trading for an attractive valuation.

Given the management guidance of around 5% revenue CAGR going forward through 2027, I think analysts are counting on margin expansion to help EPS growth. Analysts are expecting year over year EPS growth of 12.85% for 2024, 26.94% for 2025, and 22.74% for 2026 on average.

While I think margin will expand, I don’t know if it will expand as much as analysts think. Given competition could make substantial margin expansion tougher, I think Ducommun might have a harder time to meet 2026 EPS estimates. Nevertheless, I think the continued recovery of the commercial aerospace business and the growing defense business will help Ducommun meet or exceed 2024 and 2025 estimates.

Although I am not as optimistic as other analysts on EPS growth in 2026, I still think Ducommun has upside.

Being conservative and assuming management achieves the lower end of the company’s 2027 guidance of $950 million in revenue and subtracting the $75 million acquisition placeholder (as I assume Ducommun will pay the same valuation for the acquisition as its own valuation), I get $875 million in estimated organic revenue by 2027. Assuming 15% adjusted EBITDA margin and not incorporating any earnings additions onto EV, I get $131.25 million in estimated organic adjusted EBITDA by 2027 and a stock price of $66.15 per share by the end of 2026 using a forward EV/EBITDA valuation of its 5 year average of 9.07.

Assuming the consensus analyst estimate of EPS of $2.90 in 2024, $3.68 for 2025, and $4.52 for 2026, that’s another $11.1 in EPS by the end of 2026. I don’t know if the company will meet the consensus 2026, so my estimate for cumulative EPS by the end of 2026 is $10.75.

In terms of a very rough estimate that assumes management retains all of the earnings per share on the balance sheet for simplicity’s sake, I add $66.15 to the $10.75 and get a present fair value of around $61.05 per share using a discount rate of 8%.

Given my fair value assessment, I do agree with the board that Albion River LLC’s non-binding offer of $60 in cash per share does not fully reflect Ducommun’s long term growth initiatives although the offer isn’t all that different from my albeit conservative calculations. If management outperforms in terms of margin than my estimates, the stock would have higher upside.

My Rating

I rate Ducommun a ‘Buy’ and I would own it in a diversified portfolio that includes the Magnificent Seven. Given Ducommun isn’t a big company with numerous competitive advantages, I would not ‘overweight’ the stock, however.

I have a price target of around $59.34 per share in around a year given my present fair value calculation and incorporating a 10% margin of safety although it could take longer for the stock to reach that level if demand isn’t as strong as expected.

I would follow earnings reports and the state of the commercial aerospace industry. I see earnings reports and large contract wins as potential catalysts.