Air Methods (NASDAQ:AIRM) is a company that has been on my radar for a while, as I covered the business in more detail in this article, written in August. The company is mainly a play on medical transportation services in the U.S., while it has a smaller tourism business as well. Air Methods has seen rapid growth in recent times, in part driven by acquisitions. These acquisitions, the resulting debt load, poor tourism trends and consolidation among insurers (being the clients of Air Methods) has caused concerns for investors.
Shares have been cut in half, now trading just below the $30 mark after trading at $60 as recent as the summer of 2014. At these levels, shares look quite appealing.
Nearly 90% of sales from Air Methods are derived from medical transportation. The smaller tourism business has been established in 2013 following an acquisition, focusing on both Las Vegas and Hawaii.
Most of the medical transportation business does not involve contracts. Air Medical operates a fleet of nearly 500 aircraft (mostly helicopters) which carry out transports between more than 200 bases. While Air methods does not have fixed contracts for most of the flights, demand is relatively stable of course. An average flight goes for $12,000 apiece as increased coverage under Obamacare has provided a tailwind in recent years. This has been partially offset by a strengthened position of healthcare providers which demand cheaper prices and longer payment terms.
A major worry for some investors has been the fact hat Medicaid and Medicare combined make up 60% of the payer mix, with commercial and self-insurance making up the rest. This results in a key political risk, but given the state of the polls at this point in time, this risks seem fairly minimal at this point in time.
Solid Growth, but What's Next?
Acquisitions, organic growth and Obamacare have resulted in a rapid increase in sales. Revenues rose from roughly $250 million in 2006 to nearly $1.1 billion in 2015. Operating margins have typically come in between 10% and 20% of sales, currently trending toward the higher end of the range.
These above-average margins and dependence on government sponsored programs pose a real risk. In case conditions change for the worse, both sales and margins could come down, providing a double whammy to operating earnings. Not only is this risky in terms of the reduced profitability, the balance sheet of the company has gotten quite leveraged as well. A reduced earnings potential could therefore result in high leverage ratios, even if absolute debt levels remain unchanged.
Reviewing Recent Events
Air Methods has not yet reported its third quarter results, but the recent monthly transportation numbers do not look very encouraging. Second quarter sales rose to $293 million, an 11% increase on an annual basis. Growth has in part been aided by the $222 million acquisition of Tri-State, been announced earlier this year. Excluding this deal, growth came in at 7% but that has been aided by opening of new flight bases as well.
So-called same base growth was essentially flat in the second quarter and down by 6% in July, driven by though comparables vs. the year before. Same-base transports fell by 12% in August, but this was in part driven by poor weather. If weather cancellations are corrected for, same base volumes were down by 2.8%.
September was not much better as same-base transports fell by 6.9%, with weather hardly having an effect as same-volumes were down by 6.5% after the weather correction has been taken into account. While same-store sales were down in these months, not boding well for the Q3 results, overall transportation continues to be up thanks to opening of new bases and the impact of Tri-State.
These declines in same base numbers are concerning as they have the potential to impact earnings. Note that the company earned $1.20 per share in the first six months of the year, or $47 million in actual dollar terms. Same-base growth was over positive for this period of time, being a major driver behind the growth, as earnings totaled $1.00 per share in the first half of 2015.
The issue remains the balance sheet, of course. Net debt (including lease obligations) stood at $935 million at the end of the second quarter. In August, I estimated that EBITDA could come in around $350 million this year. The 2.7 times leverage ratio seems manageable for a capital intensive business, yet revenues and margins could potentially be volatile going forwards, certainly if the company might lose some sales or would have to give up some margins.
The good thing is that capital intensive businesses have the potential to deleverage rather quickly, if they cut capital expenditures in a big way. Air Methods has many potential ways to deleverage. The company is still expected to earn over $100 million this year, depreciation charges run at roughly $90 million a year and the company is not paying out any dividends to its shareholders. These potential sources of cash flow and potentially improved working capital management (accounts receivables) can go a long way in order to reduce the net debt load.
The second half of the year is traditionally a stronger period for Air Methods, certainly as Tri-State will contribute to the entire period. This is offset by soft monthly traffic results for the months July, August and September. The $2.91 per share number reported for 2015 should still be attainable. I note that earnings for the first half of the year came in twenty cents ahead compared to the same period last year. This gives the company a head start in order to repeat 2015's results.
That suggests that shares trade at just 10 times earnings as the $2 billion enterprise valuation is equivalent to less than 6 times anticipated adjusted EBITDA of $350 million. The good thing is that management is aware of the cheap multiples, recognized by management on the second quarter earnings conference call. Given the cheap multiple it favors share repurchases over additional dealmaking.
With earnings power at $3.00 per share, buybacks certainly make sense, although a slight reduction in leverage multiples would be applauded as well. This is certainly the case as margins come in above their long term average of 10-15%. If margins were to retreat towards 15%, EBITDA might fall from $350 million toward $300 million, resulting in a 0.4 times increase in leverage. Any additional declines in profitability could make the situation potentially dire for equity investors.
If I work with a 15% margin scenario, earnings come in at around $2.25 per share as the earnings multiple would only rise towards 13 times in such a case, still being a non-demanding multiple. While I understand that risks are towards the downside now, in terms of earnings potential and revenue trajectories, the current valuation prices in quite some bad news already.
If management refrains from using too much leverage as they continue to manage the business effectively, margin compression and leverage risks are not large enough to outweigh the potential of the very low valuation. Given the situation I am a buyer in the $27-$28 region, looking to expand any position following the release of Q3 earnings results.
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.