Air Transport Services Group: Leveraging Strong Air Cargo Demand

 

Despite ongoing growth in e-commerce and strong demand for cargo freighters, Air Transport Services Group (ATSG) has struggled to much headway this year. The shares have rebounded some since late July, but they’re down about 6% since my last update, and the company lags other transports like Atlas Air (AAWW), Deutsche Post DHL (OTCPK:DPSGY), FedEx (FDX), and UPS (UPS) on a year-to-date basis as well.

I believe at least some of the lagging performance has been due to the negative impact on the business from weaker passenger-related leasing revenue (tied to COVID-19), but that headwind should ease from here. In the meantime, the company not only continues to find more customers for its freighters, driven by strong e-commerce traffic, it’s making a sizable commitment to further passenger-to-cargo conversions in the coming years, as well as leveraging opportunities to serve an aging B757 cargo fleet with A321 conversions from its PEMCO joint venture.

I still see fair value in the low-to-mid-$30s, but this is a difficult company to model given frequent changes to the capex plans, and it’s not a particularly popular stock on the Street despite its leverage to ongoing e-commerce growth and Amazon (AMZN) in particular.

 

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Air Transport Services Group: Leveraging Strong Air Cargo Demand

Air Transport Group Executing, But Headwinds Continue To Weigh

In terms "controlling what it can control", I believe Air Transport Services Group's (ATSG) management team is doing a good job. Even so, there are worries about Amazon's (AMZN) future plans for its Prime Air operations, possible competitive losses to Atlas Air (AAWW), higher rates, and access to planes continuing to weigh on the shares, which have underperformed Atlas Air quite significantly since March of this year.

I expect Air Transport to expand its business relationship with Amazon over time, but there are no guarantees. Likewise, I believe the company's efforts to expand its ground-based service and conversion businesses will pay off, but not for several years. Although the overall air cargo and leasing environment remains healthy, escalating trade disputes could threaten that and Air Transport doesn't have a great track record of free cash flow or ROIC generation. That said, there still appears to be worthwhile opportunity here for those investors who can get comfortable with the risks.

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Air Transport Group Executing, But Headwinds Continue To Weigh

Air Transport Services Group Seems To Have Found A New Cruising Altitude

“It's different this time” is probably one of the most expensive phrases in the history of investing (although “what could possibly go wrong?” might be a close second), as it often represents a period of peak optimism that lures in investors right before the company/industry snaps back to reality. On the other hand, failing to notice and accept a new fundamental reality can also be pretty expensive, as it means you may stand forever on the sidelines watching a great story go by.

That brings me to Air Transport Services Group (ATSG) – a company and stock that I have liked for some time that may actually be seeing a fundamental transformation in its business. While I liked the shares a year ago, I didn't really expect another 50%-plus move in the shares. The company's bull case has materialized, though, as demand for its freight aircraft has picked up and the company continues to build out its fleet.

And now? Historically, this company has had a hard time earning attractive free cash flow and its EBITDA performance has been erratic. I'm nervous about assuming that the next 10 years will be a radical departure from this, but the company's relationship with Amazon (AMZN) is a major driver of change, and the company's e-commerce venture in China could prove very lucrative. I still consider this a high-risk investment (this type of business tends to have a lot of competition, a lot of debt, and relatively low returns), but a fair value in the low $20's does not seem crazy to me today.

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Air Transport Services Group Seems To Have Found A New Cruising Altitude

Seeking Alpha: Air Transport Services Group Ready To Take Off

I liked the direction of Air Transport Services Group (NASDAQ:ATSG) back in April, as the company had taken steps to reduce some of the contract risks with its huge DHL business, was building business with the likes of Cargojet (OTC:CGJTF) and West Atlantic, and was about to begin repurchasing shares. What I didn't like so much was the valuation, and with the shares basically flat since then (up 2% against a 1% decline in the S&P 500), I don't feel like I've missed out on all that much.

There are some legitimate areas of concern in the global airfreight market. Airfreight volumes are up for the year, but have been outpaced by capacity growth and it's hard to find much optimism regarding the health of the U.S. or Chinese economies. That said, Air Transport's regional focus is an important differentiator, as it gives the company exposure to e-commerce growth, and the company's efforts to diversify its business seem to be on a good track. I wish my fair values weren't so closely aligned with the sell-side consensus, but I do think fair value for these shares lies between $11 and $12 today and supports an interesting value opportunity.

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Air Transport Services Group Ready To Take Off

Seeking Alpha: Air Transport Group Delivering On Schedule

Sane and rational competition is a good thing for most industries, but especially for the operators of aircraft. While domestic passenger airlines like Delta (NYSE:DAL) and Alaska Air (NYSE:ALK) have taken advantage of improved conditions to post some good results, so too have conditions improved for freight/air cargo operators like Air Transport Services Group (NASDAQ:ATSG). In the case of ATSG, though, it's not just about a better overall operating environment, as the company's internal expense and capital management efforts have started to pay off as well.

Air Transport's shares have done alright since my last article, boosted (I think) by more optimism around the air cargo space and growing expectations that the company would start returning cash to shareholders in 2015. The 11% move in the shares since that September piece has just slightly outdone FedEx (NYSE:FDX) and outpaced the S&P 500, but has lagged Atlas Air (NASDAQ:AAWW) which has climbed about 25% in that time. With the rise in Air Transport shares, I'm not as bullish as I was before. I still think there is room for the company to outperform and an argument for a share price in the low double-digits, but a mid-teens undervaluation isn't quite enough to get my wholehearted bullishness today.

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Air Transport Group Delivering On Schedule

Investopedia: FedEx May Be In Sight Of Bargain Pricing

I've been a FedEx (NYSE:FDX) skeptic for some time now, and despite a few spikes in February and March, the stock has mostly chopped around in 2012 as investors try to digest the impact of slowdowns in Europe and China on global transportation. Although I still believe that FedEx enjoys too much benefit of the doubt with the sell-side analyst crowd, I do acknowledge the value in this company's nearly impossible-to-replicate infrastructure and its leverage to an eventual economic recovery. Overall, maybe FedEx is getting within sight of being attractively valued.

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Investopedia: Air Transport Services - A Riskier Play On A Cargo Recovery

Investors know that transport stocks can be a good way to play fundamental macroeconomic trends; North American railroads like Union Pacific (NYSE:UNP), for instance, have done quite well since the United States economy started to pull out of the recession. Likewise, the recent malaise in the global economy (particularly Europe and China) has done no great favors for international cargo carriers like UPS (NYSE:UPS) and FedEx (NYSE:FDX).

Air cargo has definitely stagnated of late. While conditions haven't seen the crisis levels that some seaborne shippers have seen, companies like Hong Kong Airlines and Cathay Pacific have seen significant declines in cargo volumes and have been cutting back on capacity. This is bad news for air cargo players like Atlas Air (Nasdaq:AAWW) and Air Transport Services Group (Nasdaq:ATSG) as well, but the question remains whether this market will rebound later this year. While I recently highlighted Atlas Air as a worthwhile stock to consider as a late 2012 rebound play, more aggressive investors may also want to consider Air Transport Services.

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