Air Transport Group Delivering On At Least Some Of Its Potential

 

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.

 

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Air Transport Group Delivering On At Least Some Of Its Potential

There's An Interesting Gap Between Air Transport's Underlying Performance And The Share Price

It’s been a frustrating run for Air Transport Group (NASDAQ:ATSG) since my last update on the company. While e-commerce has been red-hot, the company’s diversification toward more passenger and military worked against the company, arguably contributing to underperformance relative to customers like Deutsche Post DHL (OTCPK:DPSGY) and UPS (UPS), rivals like Atlas Air (AAWW), and the broader freight/logistics space.

I don’t believe there is anything wrong with Air Transport’s business, and if anything the outlook is stronger, given fully booked fleet additions in 2021 and customers already discussing plane availability as far out as 2025. Moreover, Amazon (AMZN) remains a committed partner, recently exercising warrants to take its stake to 19.5% and sending a little cash back to Air Transport (a cash exercise on a large chunk of warrants).

This is always a challenging business to model, in no small part due to the fact that capex decisions are tough to model beyond a year or two out. In any case, I don’t expect any meaningful slowdown in e-commerce, nor do I expect any particularly compelling challenger to emerge to Air Transport’s fleet of converted 767s. With a fair value in the low-to-mid $30’s, I think this is a name worth some consideration.

 

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There's An Interesting Gap Between Air Transport's Underlying Performance And The Share Price

Air Transport's Business Looks More Stable Than The Share Price

Share prices are almost always more volatile than underlying business trends, but the last year or so at Air Transport Group (ATSG) looks like a more extreme example of this. Although the company has expanded its business with Amazon (AMZN), re-upped most of its business with Deutsche Post DHL (OTCPK:DPSGY), added UPS (UPS), and taken strides to securing better future freight conversion supply, the shares have bounced between $19 and $26, with worries about U.S.-China trade policy no doubt playing at least some role in that volatility.

Simply considering the commitments Amazon had made to expand its proprietary logistics operations, I’m just not that worried about Air Transport’s outlook, and I think that Amazon relationship provides some floor to the business. Likewise with the deeper ties with the Department of Defense brought in with the Omni deal. EBITDA margins of 30%-plus in 2019 and 2020 can support a 6.75x forward EBITDA multiple and a fair value in the mid-high $20’s, suggesting these shares still have upside.

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Air Transport's Business Looks More Stable Than The Share Price

Air Transport Group Shareholders Have A Lot To Consider

It’s been a tough stretch for Air Transport Group (ATSG) since the company’s early October announcement that it would be acquiring Omni Air, with the shares down about 20%. The “good news”, if you really want to call it that, is that the company’s closest comp, Atlas Air (AAWW), has been even weaker, as have FedEx (FDX) and UPS (UPS) (with Atlas and FedEx also underperforming Air Transport on a trailing twelve month basis), as concerns have grown regarding the impact of trade protectionism on cargo/shipping demand. Of course, Air Transport did itself no favors with a miss and guide-down for the third quarter.

Between uncertainties in the global economy, Amazon’s (AMZN) plans, and management’s ability to execute, there’s a lot for Air Transport shareholders to chew on. Underlying aircraft demand seems strong, and management has generally been reliable insofar as being careful about adding capacity ahead of real demand. With the Omni deal, Air Transport will also have a more stable block of revenue coming from the Department of Defense, as well as some longer-term fleet management options. Although these shares do seem undervalued, I’ve lowered my expectations and this is a tough stock to model given the substantial uncertainties in the business.

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Air Transport Group Shareholders Have A Lot To Consider

Air Transport Group: Warning, Contents Have Shifted In Flight

Air Transport Group (ATSG) has chosen to alter its business in a pretty significant way with the $845 million acquisition of Omni Air. With this acquisition, Air Transport will be far more exposed to passenger-oriented ACMI and charter services, and the company will also add Boeing (BA) 777s to its owned and operated fleet.

I’m not unreservedly bullish about this deal, as I believe it adds operating complexity to a company that already had a track record of so-so execution in its core operations. It also likely takes an Amazon (AMZN) acquisition off the table (however likely that really was) and could lead Amazon to turn more toward Atlas (AAWW) as its provider of choice for future air cargo expansion needs. Adding government-funded charter services does help mitigate some of the ongoing cargo demand risks, though, and I do believe the shares remain undervalued below the mid-to-high $20’s.

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Air Transport Group: Warning, Contents Have Shifted In Flight

Air Transport Not Just An Amazon Story

Air Transport Group (ATSG) shares have done well over the past year, but the shares have been stuck in a $6/share trading range since May, as inconsistent execution has blunted some of the benefits of the company’s transformative relationship with Amazon (AMZN). Despite those inconsistencies, management continues to build the business outside of Amazon, adding more 767 customers and launching a long-term effort to expand its potential operating fleet.

I believe Air Transport still has some upside from here, driven by my expectations for high single-digit revenue growth and improving free cash flow generation. I also believe that significant upside remains in the Amazon relationship, as Amazon seems to be serious about building out its independent logistics operations.

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Air Transport Not Just An Amazon Story

Even After A Big Run, Atlas Air May Have More To Give

I didn't go into my latest round of due diligence on Atlas Air (NASDAQ:AAWW) expecting to find a bargain. While the shares couldn't sustain the spike brought about earlier in 2016 with a major agreement with Amazon (NASDAQ:AMZN), the shares did start a strong rally toward the end of summer, and the shares rose another 25% or so after the U.S. presidential election (despite the uncertain ramifications of the new administration's policies on international trade). And yet, while there are a lot of unknowns about future margins and the air cargo supply/demand balance still isn't great, these shares just might still be too cheap.

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Even After A Big Run, Atlas Air May Have More To Give

Air Transport Group At A Comfortable Cruising Altitude

I really can't complain about how Air Transport Group (NASDAQ:ATSG) has worked out - the shares are up about 50% from my last update, with the stock shooting up on confirmation of an extensive long-term deal between the company and Amazon (NASDAQ:AMZN) that will see Amazon become the major leasing partner for this cargo aircraft specialist.

In the "so, what's next?" world that is Wall Street, Air Transport is probably looking at a more sedate remainder of the year in terms of big market-moving news. The company has a lot of work to do to get the Amazon agreement up and running, and that is going to bring start-up costs into the financials that will likely obscure the generally solid results of existing operations with partners like DHL and the growing "other" operations like maintenance. Longer term, though, I would not be surprised to see the Amazon relationship expand further, nor to see the company's Chinese joint venture prove to be an underrated growth opportunity.

As for the shares, I think the Street basically has this one dialed in today. I come up with a fair value range of around $14 to $16.50, so there is some upside (particularly if there would be a faster-than-expected expansion of the Amazon relationship), but it's not a striking bargain like before.

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Air Transport Group At A Comfortable Cruising Altitude

Seeking Alpha: Air Transport Group Finally Delivering

It has taken a while, but Air Transport Group (NASDAQ:ATSG) is finally starting to show some of the potential I thought I saw back in September of 2013 and again in March of this year. While the shares are up almost 30% since that March piece, they are up only about 15% over the September piece and lagging the market isn't a cause for celebration.

Air Transport Group appears to be in the right place and if not at the right time, at least at a better point in time. The company has retired its DC-8 fleet, has a solid fleet of 767s and good growth potential in its relationships with Cargojet (OTC:CGJTF) and West Atlantic. Air cargo demand is improving (particularly for mid-sized freighters) and the company should start generating free cash flow this year. I think relatively conservative assumptions can support a fair value well into the $9s, and it is not that hard to get into the low double-digits, and I think there's still further for these shares to go.

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Air Transport Group Finally Delivering

Seeking Alpha: Air Transport Group Looking To Recover From A Choppy Start To The Year

In a time when it seems that almost any stock has gone up, Air Transport Group's (ATSG) 13% decline since my last write-up is particularly disappointing. I continue to believe that this is a well-run air cargo company with meaningful opportunities to improve EBITDA and cash flow, but management must convert "opportunity" to results for this stock to perform better. A couple of recent developments should encourage bulls, and the stock remains at a valuation where I think a closer look is warranted.

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Air Transport Group Looking To Recover From A Choppy Start To The Year

Seeking Alpha: Air Transport Group Looking To Post Meaningfully Higher Cash Flow

Done correctly, equipment leasing can be a lucrative business. General Electric's (GE) GE Capital has done quite well for itself leasing everything from jet engines to rail cars to shipping containers, and passenger jet lessors Aircastle (AYR) and AerCap Holdings (AER) have likewise performed quite well over the past year and reasonably well over the last five.

Air Transport Group (ATSG) isn't a straight-up leasing company, as about 80% of the company's external revenue comes from ACMI (aircraft, crew, maintenance, insurance) operations, but the stock has nevertheless been quite strong both over the past year and since a 2008/2009 crisis threatened the company's survival. With the company looking to generate business for under-utilized assets in an improving economy and taking a new, disciplined approach to further capex, Air Transport Group should be looking at a period of improving margins and cash flows.

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Air Transport Group Looking To Post Meaningfully Higher Cash Flow

Investopedia: Air Transport Group Offers A Value Conundrum

What is Air Transport Group (Nasdaq:ATSG) really worth? It sounds like a straightforward question, but it is really anything but straightforward. While there are certainly several positive aspects to this business, and legitimate reasons for thinking it undervalued, there are also several significant drawbacks and concerns about the long-term economic returns from the business model.

Air Freight a Bumpy Growth Story  
It likely will not surprise anyone that air freight is typically the most expensive way of shipping products, particularly those with low value-to-weight ratios. Said differently, nobody would think of shipping coal, frozen chicken breasts or family sedans by cargo plane - that's what rail, trucks and ocean-going cargo ships are for.

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