I've been spending a lot of time in the air transportation sector. Rather than provide commentary on some of the better-known brands in the space, as I've mentioned in my previous article, I've elected to concentrate on the lesser-knowns, Hawaiian Holdings (HA) being the first, and now Air Transport Services Group (ATSG).
ATSG was first brought in the limelight a few years back, when Mohnish Pabrai was being given a lot of publicity as the next Warren Buffett. After a few somewhat tumultuous years it looks like Mohnish has been cutting his holdings of ATSG, which was previously known as ABX Holdings.
The primary order of business for ATSG is really to cover all aspects of the air freight transportation business. This is primarily anchored by purchasing secondary-market (used) planes and then leasing and operating the planes, and providing various services for the air freight transportation business. Owning planes in general has not been one of the best business models in the past, so therein is one reason why this company's shares could be depressed.
However, ATSG buys in the secondary market, and is in a unique position to acquire planes on the cheap. When passenger airlines upgrade, and there are no buyers for their older planes (the aircraft leasing businesses of the past are all but dead at GE Capital and CIT Group), ATSG has the benefit of choosing the best models, gutting them, and redeploying them into the freight business.
I'm also lucky enough to know of another business with the sole strategy of buying planes on the cheap, dismantling them, and selling the various parts (primarily engines) of the plane into the secondary maintenance market. Lo and behold, this company and ATSG are both targeting the same brand of 737s and Airbus planes, given their fuel efficiency and large supply in the market. It's good to see 2 different business models targeting the same asset.
Going on to some numbers, as always, I like to use enterprise value ratios, and I'll be using a price of $5 for simplicity:
- 17.0x EV to net income
- 1.86x EV to book value, 1x market cap to book value
- 4.77x EV to operating cash flows
- 7.00x EV to free cash flow (maintenance capex about $40M)
The total capex budget for 2011 is about $170M. I estimate that $130M of that capex is going into purchasing planes and will help the business grow. Return on invested capital is just above 10%. And if I estimate a 10% growth on $130M in capex for 2011, that'll lead to about $13M increase in cash flows. The 3 analysts covering ATSG on Yahoo expect an approximate $20M increase in income, so I could be being conservative.
Current free cash flow equates to $85M, and for simplicity, if it increases cash flow by $15M for 2012 it will total $100M. I think the company deserves a valuation of 9x free cash flow, which is $900M or a stock price of about $9.
If it can consistently, efficiently deploy capital at the rate it is doing so now, in 5 years it can potentially increase free cash flow to $150M. At that point the company could approach the mid to high teens in valuation.
Why bother with the consumer-centric plays such as Alaska Air (ALK), Delta (DAL), JetBlue (JBLU), United Continental, AMR Group? Get a play with a positive ROIC, growth capex (all the other US airlines are cutting capacity), and a cheap valuation (unlike most profitable international airlines). Alaska Air has a high ROIC, growth capex, but a high valuation as well.
For a more direct comparison, there is also Atlas Air (AAWW). However, the 2 companies are not exactly alike, as about 30% of Atlas Air revenues is coming from military transport (please make your own assumptions about that part of Atlas Air's business). But as people get worried about defense spending, that could be another reason for ATSG's depressed valuation.
Atlas Air is also a similarily cheap company based on the same valuation metrics I performed for ATSG. Couple that with the fact that Pabrai may be done selling his shares (he cut a $20M stake to about $8M as of today), another institution may just see what I see and step in to fill the void in valuation.
- Current Value: $5
- Fair Market Value: $9, 80% projected gain
- Strategy #1: Buy shares outright
- Strategy #2: Sell Novemeber 2011 puts strike of 5 for 15-20 cents, yielding 3-4% in one month (this may have changed since time of writing)