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CPI Aerostructures Is Significantly Overvalued

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CPI Aerostructures (NYSE:CVU) is simply a shaper of structural craft parts, chiefly for defense contractors.

Recent enthusiasm for defense stocks has pushed nan company's banal value to section heights. Unfortunately, I do not spot an betterment successful fundamentals that warrant that banal value increase. Based connected nan semipermanent mean and caller earnings, I judge nan banal is overpriced.

Further, CVU's gross and costs nickname building is analyzable and has generated backward restatements recognizing monolithic losses respective times. Although nan consequence coming is overmuch lower, it should beryllium considered.

Note: Unless different stated, each accusation has been obtained from CVU's filings pinch nan SEC.

Business description

Contract manufacturing: CVU fabricates galore different kinds of craft parts. These see helping structures, motor assembly, lipid tanks, and physics sensors. CVU besides assembles portion kits utilized by its customers successful their assembly operations.

The institution does not create aliases creation these components but wins contracts to fabricate them from customer designs. They compete based connected assembly/manufacturing costs successful a bid fashion. Their competitory advantage lies successful proviso concatenation guidance and manufacturing installation management. That is why nan institution has truthful galore divers lines of manufacturing.

This is not a awesome marketplace for galore reasons. First, its clients are nan superior defense contractors, tremendous companies pinch bargaining power. Second, nan statement speech is connected a bid basis, designed to use nan customer. Third, though contracts usually past years, nan institution must readjust its manufacturing operations to caller types of components each clip a statement ends and a caller 1 is gained for a different component.

CVU's undesirable competitory position is reflected successful nan company's debased and adaptable margins.

ChartData by YCharts

Not growing: CVU has not accrued its operating income since 2000. The maturation shown betwixt 2000 and 2014 was eliminated erstwhile nan institution had to admit that it had generated losses connected antecedently considered profitable contracts (more connected this later).

ChartData by YCharts
ChartData by YCharts

Input costs accounting: When CVU wins a contract, nan customer whitethorn not perpetrate to circumstantial purchases. However, CVU has to put successful assembly lines, tooling, worker training, and facilities.

CVU capitalizes these costs successful inventories and successful a peculiar relationship called statement assets (in erstwhile years for illustration 2014, it was called 'cost and estimated net successful excess of billings').

Moreover, nan institution estimates a full costs for nan task and starts recognizing gross based connected costs incurred complete full expenses. Later, receivables are charged against statement assets, and different information is charged against CoGS.

This accounting believe is permitted and is nan ground down gross nickname for some services and semipermanent engineering projects. However, nan problem pinch semipermanent projects for illustration CVU's is that nan accounting requires important estimations of full statement size and costs and is prone to fierce accounting.

Unfortunately, CVU had to admit tremendous losses connected this accounting method respective times during its history. The scholar tin spot 2 examples successful nan years 1999 and 2014/5 successful nan gross and operating separator floor plan above.

In 1999, nan institution had to constitute disconnected $12 cardinal successful statement assets from nan early termination of nan MD-90 programme (a commercialized airplane). These were charged against CoGS and generated antagonistic gross margins. In 2014, nan institution recognized almost $50 cardinal successful statement losses, again charged against CoGS, generating antagonistic gross profits of $30 million. (Both cases tin beryllium publication successful nan linked 10-Ks for nan corresponding fiscal years nether nan Management's Discussion and Analysis heading).

Problematic accounting: For a institution pinch specified a analyzable (and error-prone) accounting system, CVU has besides shown problems handling its accounting and financial reporting. These problems are overmuch much recent.

In 2021, nan institution amended its yearly financial statements for FY19, FY20, and each of nan corresponding quarterly reports, to admit that it had understated inventory obsolescence and reserves connected statement assets. The restated financial statements included $4 cardinal successful further losses ($2 cardinal each fiscal year). The company's 10-K yearly study for FY21 (ended December 2021) was revenge very late, connected August 19th, 2022. The study recognized worldly weaknesses successful financial reporting (leading to nan FY20 and FY19 restatements).

Valuation

Rising gross profit margins: Although CVU's revenues person decreased YoY, nan company's gross profit margins are up significantly. This has led to a betterment successful profitability.

ChartData by YCharts

However, nan scholar should beryllium very cautious earlier extrapolating these margins into nan future, fixed that they are immensely affected by managers' estimations. It is not a matter of bad intentions from management, but alternatively that nan rumor is analyzable because they person to estimate nan revenues and costs expected from contracts that person adaptable request and return years to complete.

CVU is consistently reporting changes successful those estimates, some affirmative and negative, nether nan heading 'Favorable (unfavorable) accommodation to gross profit'. For nan 9M22 play (reported successful nan 10-Q for 3Q22), nan institution recognized $4.7 cardinal successful affirmative adjustments successful immoderate contracts and $2.6 cardinal successful antagonistic adjustments for others. The nett affirmative $2 cardinal affirmative accommodation has influenced nan company's historically precocious gross margins shown successful this fiscal year.

Riding nan defense banal wave: CVU's banal value has almost quadrupled successful nan past six months. This improvement has followed nan wide inclination of defense and aerospace stocks since October 2022, arsenic seen successful nan 2 charts below. CVU's banal value recovered overmuch much than nan indices, astir apt motivated by nan profitability betterment and nan highly debased levels it traded antecedently ($20 cardinal marketplace headdress successful October 2022).

ChartData by YCharts
ChartData by YCharts

The risks of restatement are little now: Before nan restatements successful 2014, nan institution accumulated $120 cardinal successful statement assets. Today, nan institution accumulates only $25 million. This implies that nan institution has not capitalized excessively galore costs and has not brought truthful overmuch gross from nan early without a corresponding rate inflow.

The company's CFO and moving superior buildup was a awesome starring parameter of nan ensuing debacle. Fortunately, CVU's existent CFO does not bespeak specified a scenario, and arsenic mentioned, nan institution has not built arsenic galore statement assets arsenic earlier 2014.

ChartData by YCharts

Average net valuation: For nan reasons mentioned, it is unadvised to usage caller net arsenic a metric for CVU's semipermanent profitability. A amended gauge is mean net complete immoderate play of time.

But which play should it be? Should it see nan monolithic nonaccomplishment recognitions? In my opinion, because nan institution has not capitalized arsenic galore costs arsenic it did earlier nan 2014 debacle, that play should beryllium avoided from nan profitability calculation.

ChartData by YCharts

The floor plan supra shows that nan mean operating income for nan past six years has been $0.5 million. Compared pinch a existent marketplace headdress of $50 million, this number unsocial already implies an overvalued situation.

Current net valuation: Even considering nan existent operating income of $3.7 million, CVU is not an opportunity. From this $3.7 million, CVU has to salary liking connected $27 cardinal successful indebtedness from its in installments facility. This installation accrues liking astatine premier + 3.5%, aliases presently 11.25%, according to nan WSJ. This implies $3 cardinal successful liking payments. As a result, nan institution would make pre-tax losses successful FY23 moreover if it maintains nan aforesaid business level and historically precocious gross margins.

Conclusion

CVU's banal value has almost quadrupled successful nan past six months. In my opinion, this was caused by liking successful defense and aerospace stocks, and by company-specific factors for illustration higher gross margins and a antecedently debased marketplace cap.

However, CVU's operations person not improved successful nan past months aliases years. Changes successful estimates caused nan caller profitability improvement, which could beryllium reversed later.

On an mean net basis, then, I judge nan institution is importantly overvalued. But besides connected a existent net basis, fixed nan company's liking load connected its moving superior in installments facility.

The company's business characteristics do not bid specified a premium connected mean aliases existent earnings. I for illustration to debar CVU's stock.

Editor's Note: This article covers 1 aliases much microcap stocks. Please beryllium alert of nan risks associated pinch these stocks.

This article was written by

Tomas Andrade Campanini floor plan picture

I specialize successful world micro, mini and mean size companies that waste and acquisition successful nan US utilizing a Due Diligence approach, scrapping for arsenic overmuch accusation arsenic imaginable astir nan company, and making qualitative judgments. I speak 5 languages (Spanish, English, Chinese, Italian, Portuguese). I besides create written contented utilized successful various formats including blogs, emails, achromatic papers, and societal media for financial advisors and finance firms successful a cost-efficient way. My passion is putting a communicative to financial data. Working pinch teams that see elder editors, finance strategists, trading managers, information analysts, and executives, I lend ideas to thief make contented relevant, accessible, and measurable.Homo sum, humani nihil a maine alienum puto Disclaimer: All of nan author's articles are written connected an "as is" ground and without warranty. They correspond nan author's sentiment only and successful nary measurement represent master finance advice. It is nan work of nan scholar to behaviour their owed diligence and activity finance proposal from a licensed master earlier making immoderate finance decisions. The writer disclaims each liability for immoderate actions taken based connected nan accusation contained successful immoderate articles published.

Disclosure: I/we person nary stock, action aliases akin derivative position successful immoderate of nan companies mentioned, and nary plans to initiate immoderate specified positions wrong nan adjacent 72 hours. I wrote this article myself, and it expresses my ain opinions. I americium not receiving compensation for it (other than from Seeking Alpha). I person nary business narration pinch immoderate institution whose banal is mentioned successful this article.

Editor: Naga



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