Atlas Air Worldwide: Who Needs Passenger Aircraft?
- Reduced shipping capacity of passenger aircraft lead to higher air cargo rates.
- AAWW is a pure play air freight company well positioned to fill the COVID-19 induced gap in shipping supply.
- Industry tailwinds combined with experienced management look like a recipe for a higher stock price.
Atlas Air Worldwide Holdings Inc. Overview
Founded in 1992, Atlas Air Worldwide (NASDAQ:AAWW) is a holding company that through its subsidiaries, Atlas Air, majority ownership of Polar, Southern Air, and Titan, operates in three segments, ACMI, charter flights, and dry leasing. They count DHL, Amazon (AMZN), and the US military among their customers, and while they do provide some passenger transport, AAWW is overwhelmingly an air cargo transport company. Mr. John Dietrich was named CEO in January of 2020, after five years as COO of the Atlas Air subsidiary, and 20 years with AAWW, the majority of the company's existence.
Business Dynamics and Financials
Q1 is typically the slowest quarter, and while January and February were hampered by decreased shipping due to the shutdown in China, March saw a dramatic shift in industry dynamics. Let's take a glance at the financial results, which I'll analyze by segment below.
|Q1 '20 Revenue||$279M||$328M||$41.9M|
|Y/Y Rev Change||-9.1%||7.4%||-40%|
|Q1 '20 EBITDA||$52.3M||$50.8M||$10.7M|
|Y/Y EBITDA Change||30%||43%||-70%|
Source: AAWW 1Q20 Earnings Slides
ACMI - AAWW's Aircraft Crew Maintenance Insurance segment is the largest in the world with shipping giant DHL as their biggest customer. The partnership between Atlas and DHL is strong as represented by DHL's minority interest 49% in the Polar subsidiary. The ACMI segment typically engages with customers on long-term contracts to supply ACMI/CMI. With many customers locked into long-term contracts, AAWW was shielded from immediate panic in the aftermath of the COVID-19 outbreak, but they don't benefit as much from the spike in shipping rates in the near term. As leases expire, and customers seek to lock in new rates, odds are high that more expensive contracts will be signed given the sudden drop in supply across the industry, to the benefit of AAWW. We saw reduced revenue early in the year from the lock down in China more than made up for in profitability in March, which will likely continue, confirmed by management's expectation for company net income to double in Q2. Finally, it's worth mentioning that some of the year-over-year revenue decline was actually transferred to a gain in the charter segment, so it's important to look at the performance of all the segments together.
Charter - Traditionally this segment offers shorter duration leases for specific flight plans at higher hourly rates than ACMI. As freight capacity dropped and demand spiked, AAWW was able to make use of five planes added in 2019 in addition to pulling one from Dry Lease to Charter to serve its customers. It's worth noting that AAWW's military clients have restricted movement during the pandemic to essential cargo. Management addressed the concern on the conference call by citing huge demand for commercial shipping, so any decrease in military demand would almost immediately be made up for in commercial markets. It also bodes well for future demand as overall rates are highly elevated given the drop in supply as military spending comes back online. The charter business does bare some risk to fuel prices, so dramatic short-term changes will impact the company. Fortunately management addressed this again, citing that charter flight fuel prices are tied to a fuel index, so in the long term, AAWW bares very little fuel pricing risk. Given the increased demand and higher cargo rates, it's easy to see why this segment excelled in the quarter, and tailwinds remain going forward
Dry leasing (aka Titan subsidiaries) - Dry leasing involves leasing an aircraft only, while crew and all other costs associated with operating the plane pass to the client. While this segment appears to have performed terribly at first glance, a significant portion of this drop can be accounted for by a shift in assets from dry leasing to charter.
We'll take a look at what I believe to be the top opportunities for the industry, the company, and a wildcard.
Industry - The obvious opportunity in the medium term are the reduced flight schedules of passenger airlines which led to a reduction in current and future fleet sizes among major passenger airlines as they look to reduce costs and debt. About 50% of the world's air cargo is carried in the bellies of passenger aircraft, and that cargo will need a new home.
AAWW - As passenger airlines look to reduce fleets, AAWW could be opportunistic making discounted aircraft purchases that would fit right into their dry leasing business. As management started on the call: "Our dry leasing business should see some great investment opportunities and there should be attractive aircraft that can be freighter conversions like 767-300, 737-800, possibly A330-300s or A321-200s."
Wildcard - The effects COVID-19 will have on the supply/demand dynamic represents a significant wildcard. Rather than level off, we could see another spike in cargo rates as military spending increases as Covid levels off or passenger flights are again grounded in the event of a 2nd wave.
I'll take the same approach as opportunities by looking at the top risks for the industry, the company, and a wildcard.
Industry - The flip side to the reduced cargo capacity of passenger airlines is that there are more planes available purely for cargo flights. This risk hasn't panned out in the last two and a half months as we saw air freight rates sky rocket in mid March, remaining significantly elevated two and a half months later. Management directly spoke to the concern: "A dedicated freighter is just so much different, right? A passenger aircraft does not have a cargo door. It can’t handle pallets above the wing. It can't handle palletized cargo. "
AAWW - Because the company utilizes leverage and does not have diversified revenue streams outside air freight, AAWW might not be able to take a hit to the industry as well as some of the larger players. That being said, AAWW pays an average coupon rate of 3.2% with the majority secured by aircraft assets. Despite that, management is taking a conservative approach implementing a few cost cutting measures, using boosted profit from higher cargo rates to decrease leverage. Lastly, they are not locked into any aircraft purchases providing flexibility in a downturn.
Wildcard - The anti-China rhetoric in Washington has noticeably stepped up. If we experience a meaningful deterioration in international relations that impacts shipping, it will likely mean lost revenue for AAWW. However, given DHL, the US military and Amazon are significant clients, I would expect the percentage loss to be relatively small.
CEO and Management Team
Over the long term, the CEO and management team have the power to either create or destroy shareholder value, so I think it's important to listen to at least one conference call and examine their history to get a feel for their character as well as possible strengths and weaknesses.
From an experience standpoint, CEO Dietrich is exactly who you would want at the helm with 20 years at AAWW and former experience at UAL. The passenger side experience is especially relevant at the moment given the dynamic between the passenger and cargo industries. The management team makes it their business to understand that dynamic and they were happy to provide some education on the call: "I'll just add to that, that you know about 90% of the passenger aircraft have been parked or non-operating, that's about 21,000 aircraft, so 90% of them. And normally 50% of the world's air freight flies in a passenger aircraft." It's comforting to know that management has a close eye on their sister industry, so they can make adjustments as needed.
In terms of stock ownership Dietrich owns roughly $3.3M, exceeding one year's salary which is a good sign. There were no open market purchases by insiders, but neither the CEO or CFO have sold since November of last year. Even then, the CFO had been selling in regular blocks once per month, not a cause for concern.
The management team had clear answers for the questions they received, and if anything served to tamper expectations despite great results and tailwinds going into the second quarter. They gave concise answers explaining why they were not eligible for government money seen across the rest of the industry, and explained why the damage seen in the passenger industry has served as a boon for cargo. Lastly they explained that they (and presumably the rest of the industry) will be cautious adding capacity until there's better clarity on the effect unemployment has on consumers and demand in general.
Conclusion and Recommendations
Whether it's a cargo plane or a cargo plane company it's great to have a tailwind at your back, and that's certainly the case for AAWW at the moment. I say "at the moment" because going back to 2006, this has been a cyclical stock with the price spending the majority of its time between $30 and $55. Given the near- and medium-term tailwinds, I've started building a position at $40 looking to add should it trend toward $30 while lightening up above $50. I wouldn't be comfortable with a buy and hold approach given the historical cyclicality of the company, and I will personally treat this as a trade using covered calls to add income while I wait.
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