Atlas Air: Back on the Right Track with DHL Deal

| About: Atlas Air (AAWW)

The airline industry is not a good place to be these days. In general, I think it is one of the more risky investments. Unexpected airline tragedies can have a swift and dramatic affect while the troubled economy and rising costs, fuel in particular, make it virtually (but not completely) impossible for any to remain profitable.

Atlas Air Worldwide Holdings (NASDAQ:AAWW) is in a slightly different category in that they primarily transport cargo, not people. Therefore their revenues aren’t affected nearly to the degree of commercial airlines in the case of tragedies. Unless, of course, there is a catastrophe that would result in the FAA restricting all air space as it did on September 11, 2001. During that period, Atlas’ planes were grounded along with every other airline, resulting in a significant loss of revenues.

Atlas’ susceptibility to fuel costs, however, is another issue. Fuel prices have reached record highs this year. The fuel cost for Atlas during Q2 was nearly 50% higher than it was in Q1. Before this, Atlas was doing rather well. Its 2007 net income of $132.4 million was more than twice what it was in 2006. But now the consequence of being dependent on fuel is rearing its ugly head and the company is facing trouble having already lost $5.3 million in Q1 2008.

To make matters worse, military charters, a big part of their business, are down and will likely continue to decline. Their stock recently took a big hit falling to a low of 43.86 on July 8th and only recently started making a comeback recovering 12.8% of its price. This is well illustrated in its stock chart.

Yes, it is clear that Atlas has been having some difficulties. But that may all be about to change. According to Atlas’ Q2 2008 earnings call transcript their "direct fuel price exposure goes away in October when our Polar subsidiary begins flying under its long term block space agreement with DHL Express.” DHL expects the 20 year agreement to improve its level of service and efficiency for routes between the US and Asia.

This is a win-win deal since it ensures DHL will have increased air capacity on Trans Pacific air routes while guaranteeing Polar a steady stream of cash flow. Towards this end, DHL recently paid $150 million to Atlas Air Worldwide Holdings for a 49% stake in Polar Air (with a 25% voting interest). But it will also serve to shield Atlas from the volatility of fuel prices and push the company back on the road to profitability.

Personally, I think selling part (if not all) of Polar is a good idea. When AAWW bought Polar in 2001, it was to offer complimentary services to their existing Atlas Air subsidiary while benefiting from various synergies. It also served to provide a foothold into the Japanese market.

While it did provide the latter, they never really captured much of those promised synergies and AAWW often found itself bogged down in trying to combine two very different companies, with different business models that were too set in their ways. The two airlines simply weren’t very compatible. They’ve gotten better at slowly merging the crews and procedures over time, but it’s taken far too long and they still have a long way to go. Plus, Polar also tends to have much higher expenses than Atlas Air due to the nature of their businesses. Atlas leases airlines on an ACMI contract basis (AMCI is an acronym for aircraft, crew, maintenance and insurance).

This means that the customer is responsible for all other expenses including fuel. Polar on the other hand offers scheduled freight services and needs to absorb the cost of rising fuel themselves. ACMI inherently tends to be more profitable and Polar carries a disproportionate amount of AAWW’s overall annual expenses. Yet, part of those expenses were always assigned to the more profitable Atlas Air due to the cost accounting methods used. Some have claimed that purchasing Polar in the first place was a failed experiment.

While I do not know if I would go quite that far, perhaps AAWW’s management finally agrees that the acquisition wasn’t all that they had hoped for. The sale to DHL is providing them with an excellent opportunity to reduce much of Polar’s cost handicap.

The move is also in line with Atlas’ general strategy, begun a few years ago, to take a more conservative approach with the company’s direction. According to William J. Flynn, President and CEO of AAWW, Atlas has “substantially de-risked our business over the past two years and our focus is on long term contracts that improve our revenue and earnings stream visibility.” They are succeeding in doing just that with the DHL deal.

Additional wise moves have been to focus on securing long term, predictable contracts and purchasing more fuel efficient planes. These are all steps in the right direction. But what I’d really love to see is them purchasing Toyota (NYSE:TM) Prius branded hybrid planes … when they exist. But that’s a story for another day.

Disclosures: The author is Seeking Alpha’s Director of Contributor Relations and in the past has provided consulting services to Atlas Air Worldwide Holdings.

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