Aerojet Rocketdyne Holdings (AJRD:US) is a little-known company heavily involved in the rocket industry. Eric DeLamarter, portfolio manager at Half Moon Capital, believes AJRD is a hidden gem offering large upside with relatively little risk. Poor investor relations have scared the public away, but with the recent hiring of an experienced CFO, communication should improve. With an interesting opportunity to sell off a vast amount of unneeded land coupled with the ULA Vulcan contract decision coming soon, DeLamarter forecasts a lucrative future for AJRD, which has already begun to play out with a 26% jump since Trump’s election. DeLamarter is currently the number one ranked analyst on SumZero, having posted 23 investment ideas with an average return of 41%.
SumZero: What about Aerojet Rocketdyne Holdings, Inc. (“AJRD”) initially caught your eye as a value investor?
Eric DeLamarter: We first got involved with AJRD back in 2011 when it was about half the current size and called Gencorp (GY). We initially started doing research on the Company because of its large non-core land holdings that were not reflected on its balance sheet. We worked with a couple local real estate brokers in Sacramento to estimate the value of these holdings. Different scenarios indicated the value of the land implied we were getting the core rocket propulsion business for free. Concurrent to this, the defense sector was deeply out of favor. The Company, however, had nearly zero exposure to the drawdowns in the Afghan and Iraq theaters that were impacting others in the sector. Unlike almost all defense contractors, AJRD’s backlog and revenue were in fact growing as its missile defense programs were a DoD priority (this remains the case today).
AJRD’s stock got caught in the downdraft of the sequestration panic in the summer of 2011. This was when we first fully sized-up our position. We scaled it back in 2014, continued closely monitoring it and then sized it back up last fall following the overreaction to the ULA news. It is currently our highest conviction long.
SumZero: What is the market missing?
Eric DeLamarter: The convergence of a number of factors has led to AJRD’s mispricing. This includes confused competitive dynamics, misperception of several headlines, complex financials (cash earnings and FCF are obscured by non-cash pension charges and environmental expenses, D&A is 2x capex, forward interest expense is significantly lower and 85% of its R&D is customer-funded) and the underappreciated presence of real estate holdings (although a less significant a part of the story now that the core business has grown larger).
SumZero: With the absence of earning calls and relatively little institutional following, how can investors feel comfortable with AJRD?
Eric DeLamarter: This is part of why the opportunity exists. We are attracted to situations where there is limited following, where we can do the work to find out what fewer may appreciate. We’ve done an extensive amount of research down to the contract level. This information requires some digging but a good amount of it is available on the DoD website and in various industry trade publications. Despite not holding earnings calls, management is actually quite accessible. We have also found some aerospace engineers and other industry professionals to be helpful resources as well.
Paul Lundstrom, AJRD’s new CFO, just started this week. He previously ran investor relations at United Technologies. Based on our conversation with AJRD since the hiring, they indicated they intend to increase investor awareness next year. In the meantime, shareholders are benefitting from the organic growth in the equity.
SumZero: Dealing with a contract-driven company, do you fear the volatility AJRD presents if a contract is lost?
Eric DeLamarter: We would contend that longer-term contracts make this business significantly less volatile. AJRD’s most attractive investment merits are its stable revenue profile with strong forward visibility that it derives from its contracts. Of course a contract can be lost or a program ended but almost all AJRD’s contracts have multi-year, if not multi-decade, lives where in several cases the government has already spent hundreds of millions of dollars to fund a program’s development. Take for instance the announcement by the ULA in September 2015 that they had decided to use a booster to be developed by Orbital ATK for the next generation Vulcan rather than AJRD’s AR1 engine. This was announced over a year ago, yet under the worst case scenario it does not start to hit AJRD’s income statement until 2018. Meanwhile, ATK does not have a proven replacement yet. It is important to note, AJRD is ULA’s backup provider. There is a decent chance ATK fails or experiences delays and AJRD ends up retaining this business.
SumZero: With SpaceX and Blue Origin continually making headlines for their achievements in the space rocket industry, do you worry that these companies will target the government contracts that AJRD currently holds?
Eric DeLamarter: SpaceX and Blue Origin are focused on the Space market and do not compete with AJRD outside this area. There are varying opinions about the viability of each. SpaceX’s volume-driven model is predicated on reducing cost per launch. This requires a very ambitious increase in demand and large expansion of the space market. It is vertically integrated with over five thousand employees, and self-funded so any delays are particularly burdensome, if not terminal. I admire Musk’s iconoclastic spirit, but am skeptical of his vision of broad interest from people wanting to be shuttled on three month each way trips to Mars.
Despite several delays, financial prospects for Blue Origin are less tenuous since it is funded by Jeff Bezos’ deep pockets. Even if both are able to successfully perform and develop propulsion systems, AJRD will be fine. This is not a binary, winner take all dynamic. Each provider can participate as there are multiple programs with different types of engines needed.
SumZero: The ULA Vulcan rocket contract will greatly impact AJRD. Will investors be safe if the contract is not won by AJRD?
Eric DeLamarter: Although we believe there is a decent probability AJRD wins this business, we do not predicate our valuation on it. At its current price you are essentially getting this potential growth for free. It should be noted that there are other large and some even larger contracts AJRD is competing for as well.
SumZero: AJRD recently moved their headquarters in order to lessen their distance from Raytheon and Boeing. Do you think this relocation will result in easier negotiations and ultimately, more deals in the future?
Eric DeLamarter: This move should make AJRD better integrated with those primes and will enable them to operate more efficiently. Back in June, AJRD and Raytheon announced a deal with the DoD whereby the Tomahawk Missile, Standard Missile 3, Standard Missile 6 and Patriot Missile systems programs were extended, and they were granted permission to reduce redundant bureaucratically required overhead costs that exist between the two companies. AJRD and Raytheon literally had duplicate administrative personnel that they can now eliminate. Increased integration with the primes increases switching costs and helps further solidify AJRD’s competitive position.
SumZero: As relocation and changes in propulsion technology have rendered the need of a buffer zone obsolete, AJRD plans on selling roughly 6,000 acres for commercial development. What kind of impact do you see this making on the business?
Eric DeLamarter: The real estate segment operates separately from the propulsion business. AJRD is not looking to build a real estate development company but is harvesting these non-core assets as effectively as possible and using the cash proceeds of the land sales to pay down debt. Think of this as another free option.
SumZero: Does the DoD’s budget greatly impact AJRD’s outlook? Are there political events to root for? To fear for?
Eric DeLamarter: The total US Defense budget has been cut significantly over the last seven years but during that period AJRD has consistently grown its revenue and backlog. All indications show that the new administration will be beneficial for AJRD.
SumZero: Is this thesis representative of your investing style?
Eric DeLamarter: I would say the AJRD investment is very emblematic of our style and the types of opportunities we seek at Half Moon Capital. We are attracted to more obscure and more complex situations such as AJRD. Our search for investment opportunities is for anomalies where the offered price has materially diverged from what we believe it is worth. These are often niche business with few or no comps, limited following and/ or are undergoing some sort of corporate event that has clouded the underlying fundamentals of the business. To find these, we typically look in the corners of the investment world for smaller, more complex situations. We review corporate events and restructurings, including recapitalizations, public offerings, CEO changes, divestitures, spin-offs, liquidations, post-bankruptcy reorganizations, litigations, demutualizations, etc.
In one of our recent letters, we used the following analogy to explain our process.
“We do not go fishing where all the other boats are crowded, but prefer the remote spots where other boats cannot or have not visited. Our strength comes from being disciplined and independent, not from having a bigger boat or more fishermen onboard. The companies in which we typically invest are not glamorous and may not even be businesses that most investors know exist at all.”
Such is the profile of AJRD.
SumZero: Where else do you see value in the market today?
Eric DeLamarter: It has been challenging to find new longs which meet our risk reward parameters lately. Headwaters (HW) and Murphy USA (MUSA) are two names we believe are attractive right now. Both have a couple potential catalysts and are mispriced in our opinion.
SumZero: How has your approach evolved over the years?
Eric DeLamarter: While we are always seeking to refine and improve our process, our value underpinning and discipline will never change. Frugality is just how we are wired. Finding bargains where price has diverged from value is the only way we know how to approach investing. Short selling, on the other hand, is a different discipline than investing on the long side.
One noteworthy area of refinement to our process has been related to timing and position sizing of our shorts. Specifically, increasing a position’s size as an anticipated event approaches and reducing the size in between catalysts. In one of our recent investor letters we discussed our process in some detail. We would be happy to pass along that letter to those interested as appropriate.
SumZero: Tell me about your investing background and investing mentors and heroes.
Eric DeLamarter: I have personally been investing and intrigued by the markets since I was quite young. Not to sound corny, but I first became intrigued by stocks when our 5th grade teacher had his uncle come in once a week to talk to a few of us about investing. He was a stock broker by trade and really brought stock picking to life for me. Sadly, he passed away last year. I was recently told that at his memorial service my former teacher began delivering a eulogy. About two lines into his prepared remarks, he paused and changed course. He proceeded to talk about how his uncle had inspired my interest in investing and how I was now managing my own fund. Unfortunately, I was not able to attend the service but will certainly always remember him fondly.
I would characterize my career path as deliberate, emphasizing deep fundamental research and focused on smaller cap stock where I believe the most attractive opportunities exist. Other than traditional investing influences like Graham, Klarman, Buffett, Marks, etc., I have been fortunate to have connected with some lesser known but very thoughtful and accomplished investors. These are guys that don’t publish their performance but manage their own capital and have generated exceptional returns. Continuously studying human behavior and psychology from Kahneman, Tversky and others has been tremendously additive as well.
SumZero: What advice would you give to someone interested in pursuing investing?
Eric DeLamarter: There are a number of qualities that I believe are required to be an effective investor. Perhaps the most critical is a deep interest and persistent drive to learn more. I have found the best analysts and managers are constantly considering different outcomes and thinking about ideas even in their spare time. You can train to be better at certain things but you can’t make yourself interested. You don’t choose your passions. I would encourage anyone pursuing a role in the industry to make sure they share this level of genuine interest.