Air Methods (AIRM) is a rare kind of business. The company mainly provides medical transportation services in a large US market in which it has near 100% coverage, complemented by small tourism operations.
The company has a stellar operating growth track record, aided by tuck-in acquisitions. Despite the rapid growth, shares have been stalling in recent times about worries about growth, tourism and consolidation among healthcare insurers.
Following a near 50% fall in the share price (compared to peak of 2014) on the back of these worries, I think that appeal is luring as the challenges can be overcome with cash flow conversion becoming a real priority. At current levels, I am scoping up a few shares.
Air Methods generates rough 85% of sales from medical service transportation, with the remainder of sales being generated from tourist flights in Las Vegas and Hawaii, operations which the company started in 2013.
72% of total sales come from patient transportation which typically does not involve upfront contracts. These revenue streams are completely variable as 229 bases generate nearly $4 million in revenues per year on average. Each of these flights costs an average of roughly $12,000 per flight as reimbursement coverage is on the increase in recent years, with "Obamacare" providing tailwinds to the increased coverage. What is worrying is that healthcare providers have become more powerful and they have demanded longer payment terms, resulting in a large increase in receivables in recent years.
Medicaid and Medicare are responsible for roughly 60% of the payer mix for the medical transportation. Self-payment stands at just 10% as commercial insurance covers up the vast majority of the rest. This dependency on these government-related programs is a key risk, certainly given the uncertain outcome of the elections.
The company operates a fleet of nearly 500 aircraft, the vast majority of which are helicopters. Most of these are owned by the company itself and they have a fairly stable average age at around 10 years.
Air Methods has seen solid growth over the past decade. Revenues have grown from merely $320 million in 2006 to more than $1.1 billion on a trailing basis. Operating margins typically came in around 10% of sales at the start of this time period. Growth, related scale advantages and the increase healthcare coverage has boosted margins to 19% on a trailing basis.
The dependency on governmental programs as well as historical higher margins are they key risks in this investment. Not just a potential change in the political landscape, but consolidation among healthcare providers and hospitals can reduce profitability as well.
The Current State Of The Business
Air Methods reported an 11% increase in sales for the second quarter, with revenues coming in at nearly $293 million. Air Medial sales came in at $253 million. Excluding the contribution of the $222 million acquisition of Tri-State at the start of this year, organic growth came in at 7%.
Note that this growth is a bit misleading as it involves new base openings as well. Same base growth came in at just 0.4% in terms of actual volumes as pricing and the opening of new basis explained the remainder of the growth. It is disappointing to see that the company indicated that same base declines came in at 6% in July despite the fact that weather did not have a real impact. The company attributes this to tough comparables, but I am not sure if investors entirely buy this reason.
Tourism revenues were down by 6% to $32 million as the strong dollar has an impact on international tourism levels in the US while the small rotorcraft unit posted spectacular revenue gains. Unfortunately, the revenue contribution of this segment is limited to just $7 million.
The modest comparable growth and higher debt load (including associated interest costs) resulted in flattish earnings. Quarterly earnings were flat at $27 million, while earnings for the first six months of the year were up by $8 million to $47 million. So far, the company earned $1.20 per share, versus $1.00 in the same period last year.
The Tri-State acquisition and continued buybacks weighed a bit on the balance sheet, certainly as Tri-State produced an estimated loss of $1.5 million in the second quarter. This resulted in accelerated training programs which hurt the company through additional costs and lower utilization rates. As Air Methods operates with net debt of $935 million (including capital lease obligations) and EBITDA is seen around $350 million this year, leverage is manageable at roughly 2.7 times.
High depreciation charges, potential to defer capital spending in case demand softens, a relative stable core business and lack of dividend commitments should provide ample opportunities to gradually deleverage alongside a high current earnings yield. The key focus in the short term is to reduce the accounts receivables and thereby improve the cash flow conversion, while reducing the leverage position.
Traditionally, the second half of the year is a bit stronger for Air Methods, and this is certainly the case as the Tri-State deal contributes to the full-year results. The company reported earnings per share of $2.91 in 2015, but only earned $1.00 in the first half of the year as the performance to date is 20 cents ahead of that already.
While some comparables are challenging in the near term, I still see potential for earnings of $3 per share this year, translating into modest 10-11 times earnings multiples. With the market valuation of just $1.2 billion, net debt of little over $900 million, the $2.1 billion enterprise valuation comes in at just 6 times anticipated EBITDA of $350 million.
It was very nice to hear CEO Aaron Todd's comments on the conference call. Given that historical acquisition multiples of 8-10 times EBITDA exceed the current valuation of Air Methods, it is unlikely that the company will pursue such deals in this environment. In fact, Air Methods has gotten more aggressive with buybacks at these levels.
The trouble for investors is that while current multiples look attractive, it is hard to judge how sustainable parts of the business and the associated margins are. Over the past decade, operating margins came in close to 15%, with margins currently exceeding this by 4% points. If we assume that 15% margins are the average normal, operating earnings could fall by $45 million given the current revenue base, hurting net earnings by some $30 million. If margins were to retreat to these longer term averages, earnings per share could fall by $0.75 per share to just $2.25 per share.
In such a scenario, a 14-15 times multiples still seems justifiable given the predictable nature of the business, although quarters can be lumpy and leverage is somewhat on the higher side. That said, leverage is always higher for asset-intensive businesses like Air Methods as they have real assets to back those loans up with. Continued earnings, lack of dividends and commitment to improve cash flow conversion should overcome any potential concerns.
While there are certain political risks associated with a potential investment, I think that shares offer compelling value at current levels. As such, I am contemplating initiating a stake at current levels, adding if we might possibly see levels in the high-twenties.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in AIRM over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.