The arrival was a little delayed, but it looks like Air Transport Group (NASDAQ:ATSG) is finally getting some of the credit I think it deserves for the quality freighter leasing business it has been building for several years. While a lack of exposure to the spot market may explain why the shares had lagged a bit before, they have risen about 15% since my last update, more or less matching Atlas Air (AAWW) over that period.
Valuation is challenging (as in “difficult to model/calculate” not “expensive”). While management is right to note the significant structural free cash flow base that the company has built, the reality is that growth is still tied to ongoing growth capex. The shares trade at a low multiple to forward EBITDA and still look priced for a high single-digit total annualized return at this level; perhaps not compelling enough for some investors today, but still with upside to margin improvement.
It’s no secret that e-commerce is a prime demand driver for Air Transport’s freighter capacity, as Amazon (AMZN) and DHL collectively account for close to half of the company’s revenue, with other cargo carriers like Cargojet (OTCPK:CGJTF) also factoring into the mix. While e-commerce demand and volume were kicked up to new levels during the pandemic, I see no evidence of slowing demand and many companies have learned a hard lesson regarding the reliability of slower shipping options.
Revenue rose 21% in Air Transport’s fourth quarter, beating expectations by about 4%. Revenue in the ACMI operations rose 21% on 19% block hour growth, while CAM grew 31% and exceeded expectations by closer to 10%. Adjusted EBITDA rose 27%, beating by 3%, with margin up 160bp to 32.1%.
With the market looking for pretty much any capacity that Air Transport can bring on, management guided well above the sell-side for ’22 EBITDA, with the $640M guide close to 10% above the prior sell-side average for ’22 and higher than a lot of ’23 estimates. Management also guided to higher capex for ’22, as the company continues to spend to expand its fleet.
With a recent announcement that the company added another four conversion slots for 767-300F conversions with Boeing (BA), the company now has 80 slots booked up over the next five years between its Airbus (OTCPK:EADSY) conversion joint venture with Precision Aircraft and Boeing, or more than half of the conversion capacity out in the market. Add in the difficulty of sourcing 767-300s for conversion and the relatively new move toward Airbus conversions, and I don’t see much chance of a rival stealing a march on Air Transport over the next few years.
Given the 11 new leases coming on in 2022 and the robust pipeline of conversions, with management having secured its feedstock for all of ’22 and most of ’23, I think it’s worth pointing out that Air Transport is effectively funding this internally – the company’s cumulative free cash flow over the last five years is slightly negative, but the company hasn’t had to take on more long-term debt to fund this fleet growth.
As I said above, there’s no evidence yet that the market is approaching saturation. Amazon has steadily pushed for more capacity (double-digit increases per year), as management there continues to build out its internal logistics capabilities in support of its Prime business as well as its third-party logistics operations. DHL, too, recently agreed to an extended and expanded contract with Air Transport.
One of the parts of the Air Transport model I like is the extent to which the business is covered by contract. While spot leasing can be lucrative when capacity is tight, as was the case last fall/winter, those rates can fall quickly when demand eases and these are expensive assets to have sitting idle. Long-term contracts with large partners does limit upside, but it also provides some protection on the downside.
Over the past decade, Air Transport has grown revenue at an annualized rate of approximately 9%, while EBITDA has grown close to 14%. While reported free cash flow hasn’t kept pace, structural free cash flow, that is operating cash flow minus maintenance capex (excluding growth capex) has grown at an annualized rate of 16%. Were Air Transport to decide to stop growing, it would generate exceptional free cash flow (over 22% of revenue in FY’21 and FY’20).
Looking ahead, my modeling assumptions work out to long-term revenue growth of 8% (annualized), long-term EBITDA growth of 9% growth, and 11% FCF growth (not structural free cash flow, but “regular” free cash flow). In addition to assuming ongoing growth in the freight market (driven in large part by e-commerce), I’m assuming that the company’s move toward new freighter types and some internal conversions will drive benefits at the EBITDA margin line and capEx line, with capEx intensity decreasing about 100bp over time and EBITDA margin improving about 300bp-400bp.
Discounting those cash flows back, I get a fair value for Air Transport in the high $30s and a high single-digit annualized prospective total return. I don’t find EV/EBITDA to be especially useful here – the shares trade at about 5.7x my ’22 EBITDA estimate (against my 9% long-term growth rate), but I’ve never found a good way to reconcile margin or growth prospects into useful forward multiples. I can tell you that the longer-term historical forward multiple has been around 6x, and that supports a fair value close to $34 today, but I think Air Transport is a different, stronger, company than it was five years ago.
Spot freight rates have definitely weakened from their peak, but I don’t think that says much about Air Transport’s immediate demand environment, nor its likely demand environment in ’22-’24. With the ongoing growth in e-commerce, I believe freight transport demand will continue to grow, and I think Air Transport will see improving margins and cash generation as that happens. This is a riskier than average stock, though, so investors will need some patience and risk appetite to see it through.
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