- There will always be a need to meet potential partners in person for business arrangements to be made.
- Private jet usage may become emphasized in the jet activity mix if businesses fly fewer people but private, where health and safety concerns can be better addressed.
- Although much of Signature's income isn't resistant, they have very low operating leverage and 30% of revenue comes from hangar rental.
- Signature will lead the recovery in aviation activity due to their superior pricing power to airliners.
- Given their ample liquidity to execute on opportunistic reinvestment opportunities in beleaguered FBOs, and their more easily recovered margins, they warrant a buy rating.
For obvious reasons, aviation stocks have fallen into substantial decline. However, while some companies in aviation are struggling to stay solvent, FBOs should be robust, especially those catering to the BG&A industry. Signature Aviation (OTCPK:BBAVF) is the only publicly listed pick to give us exposure to this industry. Although their fueling services will have been at almost zero levels for several months in Q2, their real estate income which accounts for 30% of their revenue will be doing perfectly fine, as jets have no place to go but the hangars. Moreover, we think that in a recovery scenario, private jet activity will become a much more emphasized part of the jet activity mix, even if it's lower overall, because it's a much safer means of travel for company executives and their retinues. Finally, we think that this crisis may produce attractive business reinvestment opportunities for Signature, which will be much less cash strapped due to its premium locations which command high hangar rental income compared to competitors. With companies like Atlantic Aviation, part of Macquarie's infrastructure vehicle (MIC), being on sale as well, Signature could very well pick up concessions from smaller payers for strong locations at desperation multiples.
Recession Resistant, Even to Pandemics
In the latest trading update we see the recession resistance that we hoped for in our last article. Revenues are down sharply by around 70% in the network for the month of April, with revenues down 28% since the beginning of the year. Due to the fact that labor costs can be flexed, and that fuel costs account for around 75% of their cost structure, they are able to still generate cash of around $6 million even in the current environment thanks to low operating leverage. Their ERO business was virtually unaffected by the entire pandemic, and 30% of the continuing operations revenue seems to be robust, as flight activity declined almost 80% in April while still being able to earn that buffer. We know that much of this comes from the hangar rental business. Also, since the fuel prices at which the Signature FBO sells are posted on a weekly basis, they can be adjusted accordingly to the dramatic declines in oil that we witnessed throughout this period. The fuel margin likely declined in this period, but nonetheless did not rapidly turn into a loss.
Since lock-downs have already started to come to an end in the US after Memorial Day, June should see a marked improvement from the months of March and April, where flight activity was down 77% and 66% respectively. This should hopefully return the fueling revenue to more normalized levels, although we do not expect a full recovery in flight activity this year. We think that UHNWI will still use private jets, now that travel is becoming less restricted, and that business aviation, although tentatively, will start its recovery. Over the medium term we think that it's entirely possible that companies will opt for private jet travel over business class travel for its employees when necessary especially since private jet chartering for a team or group is actually not much more expensive than business class seats. It is certainly safer from a sanitary perspective, as clients will be chauffeured to and guided through low-traffic private terminals.
Another attractive aspect of the FBO industry right now is that there are likely many beleaguered smaller players that Signature could gobble up. Signature has in the upper range of 100-200 locations. While there are very few FBOs that come even close to that, there are almost a hundred with 2 or 3 locations. Since there are extensive pro-competition legislation that stop a company like Signature from monopolizing regions and charging exorbitant fuel prices, buying large operators like Atlantic Aviation from Macquarie Infrastructure Corporation is much harder to do than smaller locations in more niche regional markets. But with the wealth of smaller operators, Signature has options.
Although there may not be too many companies that have locations that would be attractive to Signature, being able to produce some cash and have access to ample liquidity reserves during this crisis positions Signature particularly well to do some private equity-like deals as they've done in the past. These opportunistic strategic reinvestment opportunities keep the fueling revenues growing, which are Signature's most cash generative service, instead of having to move focus to more ancillary revenue sources. And given the desperation multiples at which they might be able to buy small regional FBOs, they are likely to be modestly value generative for shareholders.
Moreover, the fact that their MRO and ERO businesses are up for sale and have proven resilient in the current environment, they will likely command attractive multiples from private equity firms that still have to contend with their substantial dry-powder reserves.
Risks and Concluding Remarks
Clearly it's difficult to predict how quickly a normalization in the industry can be expected, and indeed some analysts are tentative about Signature's recent price rally. However, it is clear that compared to other aviation businesses, Signature and other FBOs are perhaps the only ones generating any income at all. Given that Signature has no maturities till 2025, and they have $425 million in total liquidity headroom at the moment, they have quite a lot of optionality in this uncertain environment. With even some cash being generated from their operations, they can act opportunistically in this environment to create value for shareholders.
At the very least, the BG&A markets are likely to recover faster than commercial aviation, and that alone is a reason to buy Signature where it's being discounted at similar levels from pre-COVID highs as commercial airliners like Qantas. Regardless of the recent rally, which indeed has perplexed many market actors, Signature is certainly an attractive aviation stock. And given that compared to Qantas (OTCPK:QUBSF), the discount from pre-COVID highs is less by only 10%, investors should definitely keep an eye on Signature going forward. Indeed, when activity recovers, Signature's margins will more quickly go back to normal, with markups being consistently applied on whatever the price of fuel might be at that time. Compared to airliners, which will have to go possibly for years with brutally low fares and higher costs due to greater sanitation requirements, Signature's income is far more likely to make a stronger and more rapid recovery to normalized levels. If Signature pulls back, it would definitely be a good moment to buy.
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Analyst’s Disclosure: I am/we are long BBAVF. 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.
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