Mesa Air Group: Regional Carrier Is A Value Pick With Upside In 2022
Summary
- Mesa Air Group operates regional flights under service agreements for other major airlines.
- While the company was profitable in 2021, higher costs related to aircraft maintenance along with ongoing Covid disruptions have pressured the outlook.
- Assuming the pandemic is controlled going forward, we are bullish on MESA with the recent selloff presenting a compelling buying opportunity.
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Mesa Air Group, Inc. (NASDAQ:MESA) provides regional air carrier services for other airlines including American Airlines Group Inc. (AAL) and United Airlines Holdings, Inc. (UAL). For travelers flying on "American Eagle" or "United Express", some of those flights are technically operated by Mesa through its fleet of 153 aircraft. The attraction is the capacity purchase agreements that guarantee fixed fees and monthly revenue for MESA while the larger carriers benefit from outsourcing short-haul connections. That said, this is a segment hard hit during the pandemic including ongoing disruptions. Mesa last reported its Q4 earnings which missed expectations, further pressuring the stock which has been extremely volatile. Recognizing the high-risk profile, we are bullish on MESA which we believe is well-positioned to rebound benefiting from several positive tailwinds in 2022.
(Seeking Alpha)
MESA Fiscal 2021 Q4 Earnings Recap
The company reported its fiscal 2021 Q4 results on December 9th with an EPS loss of -$0.21 which missed expectations by $0.33. Total revenue of $131 million climbed 21% year over year, although this was also below market estimates. The story here was significantly higher seat costs reflected in flight operations expenses as a percentage of revenue at 36%, up from 32% in the period last year. Similarly, a major theme for the company in the quarter was higher maintenance expenses which climbed 30% y/y. Management noted an industry-wide shortage of key parts for aircraft that has led to repair delays and overall higher pricing for capital equipment. The company has also been training a large group of new pilots adding about $2 million in quarterly costs.
(source: company IR)
The result is that the operating income at $5.1 million declined 79% compared to Q4 2020. On this point, the company expects elevated costs to continue through 2022 which is set to be a "transition" year for the industry continuing to deal with the effects of the pandemic. For the full fiscal year 2021, the company was still able to remain profitable with EPS of $0.43, but down from $0.78 in 2020.
To be clear, some of the GAAP loss includes a mark-to-market adjustment on investments of -$6.8 million related to the company's equity in Archer Aviation (ACHR) which is attempting to commercialize electric vertical takeoff and landing aircraft "eVTOLs". Excluding the quarterly non-cash charges and some aircraft rent charges, MESA's adjusted EBITDAR declined by 11% to $189 million versus 2020.
The takeaway here is that even with operating metrics in Q4 like available seat miles up 62% y/y and the company registering 54% more flight departures compared to the period in 2020, the financials have deteriorated. The number of block hours, reflecting the time an aircraft is in service from gate to gate, climbed 64% y/y. The reconciliation between this increase compared to smaller 21% higher revenue in the quarter comes down to the lower realized contract revenue per available seat mile, pressured by the mix of aircraft in use as well as the impact of a new contract with "DHL" for cargo services dragging some of the value averages lower.
(source: company IR)
Still, there were some positives this year with the company continuing to invest for growth adding 20 Embraer SA (ERJ) E175 aircraft to its United Express operation. The company also entered a contract with American Airlines to operate 40 aircraft for the next five years.
During this latest quarter, Mesa also made a small investment in "Heart Aerospace", which plans to develop all-electric regional aircraft. The two equity investments between Archer and Heart valued at $15 million on a cost basis of $5 million are part of the more positive long-term outlook for MESA. The company has also patterned with "Flirtey" for its "SkyDrop" to operate last-mile delivery drones on a test basis with an option to eventually control a fleet of 500 units. These types of efforts from Mesa highlight the company's long-term vision of being a leader as the industry evolves.
While the company is not issuing financial guidance, the messaging has been that the air travel demand improvement is the most positive development that will allow the company to navigate the current turbulence. Mesa currently has 200 pilots in its training program that will provide capacity for growth into the future.
The company ended the quarter with $121 million in cash and equivalents against $540 million in long-term financial debt. Net debt to adjusted EBITDAR leverage ratio of around 2.2x is stable in our opinion with the balance sheet and liquidity position a strong point for the company's investment profile relative to the broader airline industry.
MESA Stock Forecast
This was a disappointing quarter overall for Mesa with shares selling off by more than 20% on the Q4 earnings release with the market focusing on the expectations for continued earnings pressure through 2022. The airline industry continues to be a mess including the impacts from the latest Omicron variant surge which made headlines over the holidays with flight cancellations as pilots and crew were forced to take time off and quarantine.
Any bullish case for the stock at this point needs to start with an outlook that the pandemic will end. Some of the good news has been reports that the highly contagious Omicron variant with mostly mild symptoms could end up becoming the dominant strain accelerating a trend towards herd immunity from a growing proportion of the vaccinated population or those that have acquired some natural immunity. Even if Covid remains a reality indefinitely, our take is that the global economy will adapt to move forward.
It's important to note that MESA despite its challenges has been an exception in the entire airline industry by generating a profit in both 2020 and 2021 considering its fixed revenue guarantees. We like the core operating model based on capacity purchase agreements because it should be able to generate more consistent cash flows and earnings compared to regular carriers more exposed to demand trends, ticket pricing variations, and fuel costs. This is evident by the stock down 17% over the past 3-years representing an outperformance compared to larger losses from names like UAL and ALL down 37% and 42% over the same timeframe. Some sense of operating stability can help the industry regain momentum.
According to consensus estimates, the forecast is for Mesa to reach $625 million for the current 2022 fiscal year representing a 24% increase over 2021. While EPS is expected to be lower at $0.14 compared to $0.43 last year, the outlook looks stronger for 2023 under the assumption that the pandemic disruptions will be over leading to a rebound in EPS towards $0.73.
(Seeking Alpha)
In terms of valuation, remember that MESA was profitable in 2021 while industry peers are still in the red. Direct comparisons are tricky considering both the company's unique business model as well as its odd month fiscal year-end. For example, MESA trades at an 8x 1-year forward P/E based on the consensus 2023 EPS which appears as a premium compared to UAL, AAL, and Delta Air Lines, Inc. (DAL), each trading closer to 6.5x. The caution here is that those companies have a fiscal year that ends in December meaning they benefit from an extra quarter in 2023 of more normalized operations effectively skewing their ratios lower relative to MESA for next year.
The one metric that stands out is MESA trading with a price-to-sales ratio on a trailing twelve months basis of just 0.46x, as a large discount to most other airlines. Again, each company has too many differences to make any direct comparison but we are simply looking at these multiples as a reference point. We believe MESA's valuation is attractive all things considered into an improving outlook. There is also a thought that MESA's investments in disruptive tech like eVTOLs and electric aircraft support a higher valuation multiple. 
Is MESA a Buy, Sell, or Hold?
With a market cap of $220 million, MESA is an interesting micro-cap that we believe has significant upside in an eventual industry turnaround. The regional market includes flights to underserved cities is an important part of the industry and MESA remains a leader. For 2022, the bet is that operating and financial conditions improve more quickly than expected while it will be important for further Covid disruptions to be minimized.
Recognizing the significant uncertainties including the next phase of the pandemic, we rate MESA as a buy with a price target of $10 per share for the year ahead, representing a 13x multiple on the current 2023 consensus EPS. Our price target also implies a price-to-sales ratio of 0.75x which we believe is more consistent with industry peers and the company's position.
Beyond Covid, the main risk to consider is going to be based on the company's execution. We want to monitor the operating metrics including block hours and completion factors which can reflect the health of the operating environment. Deterioration to the macro outlook limiting consumer spending, possibly driven by persistently higher inflation or excessive energy costs would also be bearish for the stock. Weaker than expected results in the upcoming quarters would likely also open the door for more downside in shares.
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This article was written by
Dan Victor, CFA is a market professional with more than 15 years of investment management experience across major financial institutions in research, strategy, and trading roles.
Dan leads the investing group Conviction Dossier, where his focus is on helping investors stay ahead of market trends and inflection points. Dan’s investing vehicles of choice are growth stocks, tactical exchange-traded funds, and option spreads. He shares model portfolios and research to help investors make better decisions, via his Investing Group’s active chat room.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of MESA, UAL either through stock ownership, options, or other derivatives. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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