Erickson Air-Crane Has Scarcity, But Value Is Difficult To Judge

| About: Erickson Air-Crane (EAC)
This article is now exclusive for PRO subscribers.

Every so often, an investor will set out to research a company expecting to find a certain type of company and find something completely different. That happens to be the case with me and Erickson Air-Crane (NASDAQ:EAC). I originally began my research here thinking I was going to be looking at a small specialty aircraft manufacturer, but instead found myself looking at an increasingly diversified heavy-lift and helicopter service specialist.

Erickson certainly has some interesting points going for it. It is one of the largest providers of helicopter-based heavy lift services in the country, and management is focused on diversifying and maximizing the company's revenue opportunity. While I think consolidation and diversification can deliver interesting growth in the years to come, the debt-heavy balance sheet throws a few kinks into the valuation analysis.

Heavy Lifting, With A Focus On Firefighting

The core business of Erickson Air-Crane is the operation of a fleet of 17 specialized heavy-lift helicopters. These helicopters are used to fight fires (more than half of 2012 revenue), harvest timber (20% of revenue), and assist in construction projects. With its 25,000-pound lift capacity and the ability to carry a 2,650-gallon tank, Erickson's fleet offers relatively uncommon capabilities in remote areas where precision is important.

As mentioned, firefighting is the bulk of the company's business. Erickson's S-64 Aircrane helicopters offer fire services a pretty unusual collection of capabilities. Although aircraft like Boeing (NYSE:BA) 747s and Lockheed Martin (NYSE:LMT) Orions and Neptunes have larger capacities (24K gallons for the 747) and/or greater speed, the Aircrane has the advantage of being able to refill quickly from very small ponds or reservoirs. Likewise, relative to smaller helicopters like the Textron (NYSE:TXT) Bell series, the Aircrane offers considerable advantages in capacity.

Within firefighting, the U.S. Forest Service has been Erickson's largest customer for some time now, although the government of Italy and Greece are significant customers as well. Competition in this space is relatively limited when it comes to the larger helicopters, as only about a half-dozen companies have the scale and capability to offer these services.

Growing The Non-Firefighting Business Is A Key Priority

All things considered, firefighting isn't a bad business. The revenue per flight hour is among the best of the company's service offerings (in the neighborhood of $22,000 to $33,000 per hour), and most firefighting contracts include lucrative standby fees. What's more, global weather patterns have generally made for drier dry seasons and higher fire risk in most of the company's historical operating areas.

On the other hand, firefighting is a seasonal business, and an irregular one at that. What's more, one of the key features of the Erickson Aircrane is the ability to swap out equipment and shift aircraft between duty types - fighting fires for one season and then, in theory, hauling timber or construction materials in another. To that end, Erickson management has been working hard to expand its other business opportunities, with timber and construction being two examples.

I'm not sure there's substantial potential in timber, though. While heavy-lift helicopters make sense for lifting high-value timber out of remote areas, smaller helicopters can handle the more common lower-value loads and U.S. forestry companies like Plum Creek (NYSE: PCL) and Weyerhaeuser (NYSE: WY) have generally been good about making their timberlands accessible by conventional vehicles.

Construction could be a higher-value opportunity though. There are several pipeline projects either just getting started or on the drawing board in North America and around the world, and Erickson's helicopters could definitely play a role here. The pay generally isn't too bad, about midway between the $27,000 or so per-hour of firefighting and the $7,000 per hour of timber harvesting.

Doing Deals To Diversify

A key part of Erickson's strategy has to been to grow through acquisitions. In recent months, Erickson Air-Crane has signed two sizable deals - Air Amazonia and Evergreen Helicopters. Between them, Erickson is spending about $320 million to add over $200 million in incremental annual revenue, with the potential for meaningful operating synergies.

The Air Amazonia acquisition isn't much of a stretch for Erickson. The company operates a fleet of 14 helicopters with a major focus on the oil and gas industry. As part of the deal, Erickson will get a 3-year service deal with HRT (the soon-to-be former owner of Air Amazonia) that will cover about 50% of the unit's capacity. Perhaps not surprisingly, Air Amazonia's operations are focused on Brazil's Amazon basin.

The Evergreen deal is a more transformative deal for Erickson, and a riskier one as well. Evergreen operates a 64-craft fleet that includes 12 fixed-wing aircraft. Unlike Erickson's historical business and Air Amazonia, heavy lifting is not core to Evergreen's operations. Instead, Evergreen operates passenger and cargo transport services, search & rescue, and recreation services with the U.S. Department of Defense generating more than 90% of revenue.

Evergreen is definitely profitable (management has spoken of an EBITDA margin over 28%, against a trailing margin of about 23% for Erickson) and there should be immediate synergies with the deal. It's also worth noting that margin was generated with approximately 50% capacity utilization. On the other hand, more than half of the business's revenue has been tied to Afghanistan, and the U.S. government has been consistent in its intentions to reduce its activity and presence in Afghanistan.

Only 22 of the 64 Evergreen aircraft are owned outright (the rest are on three to five-year leases), so management should be able to re-scale the business as necessary if the defense business vanishes. That said, the fleet may need several millions of dollars of incremental investment to be fully usable again.

Manufacturing Is A Wildcard

As I said in the intro, when I first began to look at Erickson, I went in thinking this was primarily a manufacturing and maintenance service company. While it's a small part of revenue (close to 10%), it's still a relevant part of the business.

About 20 years ago, Erickson bought the type and production certificates on the S-64 helicopter from United Technologies (NYSE: UTX) (Sikorsky), making it the only approved manufacturer. In its history, the company has manufactured (or remanufactured) just 35 aircraft. While the company could probably manufacture as many as four in one year, that is not likely. Even so, just one helicopter made and sold in a year can significantly impact the company's revenue, EBITDA, and free cash flow, so that is something for investors to keep in mind.

It's also worth noting that Erickson isn't exactly a helicopter manufacturer in the same sense as United Technologies, Textron, or Boeing. Rather, Erickson largely uses preexisting frames, parts, and engines (most built for the Sikorsky CH-54) and remanufactures them into the Aircrane. Although some original parts and equipment haven't been manufactured since the late 1960's, Erickson does have the right to manufacture replacement parts. While the age of the platform certainly could be a concern to potential buyers, building and selling new helicopters is not really the business plan here, and it is not as though there are many alternative heavy-lift platforms that are significantly younger in North America or Europe.

As manufacturing (or remanufacturing) Aircranes is a relatively rare event, more basic part and maintenance activity is the bulk of this segment. The market of addressable aircraft (including CH-54s and S-61s) isn't very large, but it is a reasonably profitable business for Erickson - producing more than 15% of the company's gross profit in 2012.

Growth Potential Overshadowed By A Lot Of Debt

The biggest problem I see in the Erickson Air-Crane business model is the erratic free cash flow history and the heavy load of debt that the company carries. To be fair, neither are uncommon. If you're willing to be a little flexible as to what constitutes a "comp group" and include air cargo companies like Atlas Air (NASDAQ:AAWW) and Air Transport (NASDAQ:ATSG) and helicopter service companies like Seacor (NYSE:CKH) and Bristow (NYSE: BRS), the high-debt/inconsistent FCF model isn't exactly unusual.

I do give the company reasonably good odds of continuing to diversify and consolidate the helicopter service market, particularly if the move away from heavy lift (as seen in the Evergreen deal) is a sign of things to come. Accordingly, I think the company can likely grow at a mid single-digit rate, with deals like Air Amazonia and Evergreen boosting the long-term apparent growth rate into the mid-teens.

Likewise, I believe the company can use these deals to improve its operating efficiency - better leveraging its crews, infrastructure, and maintenance capabilities. To that end, I see at least the potential for high single-digit free cash flow margins, which would point to a long-term free cash flow growth rate of over 20%.

Unfortunately, debt throws a huge monkey wrench into the works at this point. Because of the debt, the discounted cash flow value of this company is only in the single digits. That's not all that unusual, though, as you'd see a similar result if you tried to use discounted free cash flow with most of the aforementioned logistics and services companies. To that end, using an EV/EBITDA model with a target multiple of 8x (above the comp group average, to acknowledge decent growth prospects) and prospective EBITDA that includes the aforementioned deals suggests a fair value of around $22. If you go out an extra year, the fair value today increases to $26. Investors should note that the EBITDA estimates I use in my model are lower than the company's figures, but then those who want to use the company's numbers can certainly do so if they like.

The Bottom Line

In terms of moats, I would argue that Erickson stacks up pretty well - not too many other companies or investor groups are going to want to get into the business of operating heavy-lift helicopters, and Erickson already was one of the largest operators in the business. Likewise, I like the company's efforts to diversify, leverage its scale, and become a consolidator in the helicopter services space. At the same time, though, we've all seen what can happen to companies with large debt balances and significant ongoing maintenance and capex needs. As a result, while Erickson may be trading below fair value on an EV/EBITDA basis, it's not enough of a bargain to really pique my interest today.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.