Airline Services Group Q2 Results: Capitalizing on Strong Air Cargo Demand (NASDAQ: ATSG)

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Despite the continued growth of e-commerce and the strong demand for freighters, Air Transport Services Group (ATSG) has struggled to progress this year. Stocks have rebounded since late July, but are down about 6% since my last update, and the company is lagging behind other transports like Aerial atlas (AAWW), Deutsche Post DHL (OTCPK: DPSGY), FedEx (FDX), and UPS (UPS) since the beginning of the year as well.

I think at least part of the lagging performance is due to the negative impact on business of lower passenger-related rental income (related to COVID-19), but that headwind should ease to leave this place. In the meantime, the company not only continues to find more customers for its freighters, thanks to heavy e-commerce traffic, but it is making a significant commitment to continue passenger-to-cargo conversions in the years to come, as well as ” Take advantage of the opportunities to serve an aging B757 freight fleet with A321 conversions from its PEMCO joint venture.

I still see fair value in the $ 30, but it’s a difficult business to model given the frequent changes in investment plans, and it’s not a particularly popular stock on the streets despite its leverage. on current e-commerce. growth and Amazon (AMZN) in particular.

A much needed rhythm

After weak results in the first quarter, these stocks definitely needed good news and the company had a better-than-expected second quarter.

Revenue increased 9%, beating around 5%, with strong 18% growth in Cargo Aircraft Management (CAM) business offsetting the 5% drop in ACMI operations. External customer revenue grew 33% at CAM, while ACMI recorded an 18% year-over-year increase, with an 8% decline in passenger and combined services offset by a 26% growth in sales. freight block hours. Pax / combi hours have improved by 17% quarter-on-quarter, however, and it looks like the worst is out there.

Adjusted EBITDA increased 2% year-on-year and approximately 21% quarter-on-quarter, beating expectations by approximately 10%. While the reported segment-level margin declined slightly for CAM (down 70bp to 24.1% on a 15% improvement in revenues), ACMI improved nearly six points to 16.4% on a growth of 52% year-on-year.

No relaxation of loading capacity demand

Airline sees no drop in demand for cargo freight capacity, and the company now plans to lease “16 or more” 767-300 in 2021 (up from “16” after Q1’21), with nine (or more) to come the second half of the year, and at least 10 more in 2022. Of these leases, at least 13 will go to Amazon.

Management is also positioning itself for even more passenger-to-cargo conversions in the coming years, announcing that it has secured slots for 67 conversions from 2022 to 2025. Management plans to purchase and convert more than 767-300, as well as the A321-200 and A330-300, the latter being a new addition.

The addition of A330 makes sense. Roughly similar to Boeing (BA) 767-300, the A330s have about 20% more cubic space and almost 10% more weight capacity. As a newer model (entered service in 1994 versus 1982 for the 767), A330s are generally more fuel efficient and the combination of lower operating costs and significantly more cubic space (more relevant than weight for typical e-commerce shipments) is an attractive solution. one to customers like DHL. In addition, the similarities with the A321 are such that the additional training needs of pilots are manageable.

Management is also looking forward to receiving the first A321-200 conversion of its joint venture, with two more coming in 2022. At this point, all three will be leased to CAM. As a reminder, the A321s are attractive on several levels, the jets offering an interesting alternative to the aging B757 fleets. While the B767s will remain a significant part of the airlift fleet for quite some time, finding B767s available for conversion has become more difficult, and the A321s give the company more fleet options, as well as the ability to generate income by converting other customers.

Perspectives

At this point, Air Transport sees no problem with demand on the cargo side, with the company finding customers interested in multi-year leases starting until 2025, and also willing to commit to higher rental rates. At the same time, headwinds on the company’s passenger and combi side are expected to improve from here; the number of recovered COVID-19 cases is a concern, but manageable at this stage.

Modeling air travel beyond a year or two remains quite difficult, as management has shown that they are very willing to engage in larger investment programs when there are customers ready to go. enter into long-term rental contracts. I believe it’s more than just getting fat for the sake of being bigger; As Stephens analyst Jack Atkins points out, Air Transport has grown its fleet by 93% over the past five years, but also increased its Adjusted EBITDA by 136% and Adjusted EPS by 122%.

Considering the growth in e-commerce-driven air freight demand, I think air travel is likely to grow its revenue at an annualized rate of 7-8% over the next decade, and I can see the benefit. of this figure. The relationship with Amazon will be a key driver of this growth, but the company also continues to find customer demand outside of this relationship.

I am looking for an improvement in EBITDA margins of up to 30% (31% – 32%) over the next three years, with a possible increase of up to 33%. I don’t expect a significant reduction in investment anytime soon, especially with the company reserving these conversion slots and having to buy planes to fill them, and expect negative FCF for the next five years. . Over time, I would expect positive free cash flow as the company builds on the fleet it is currently building.

Discounted cash flow suggests a fair value above 30% on a long-term average FCF margin in low numbers, but again, this model is very sensitive to changes in future investment plans. Given this, and given the company’s margins, growth and EBITDA returns (ROA, ROIC, etc.), I continue to believe that a forward multiple of 7.5x to l 12-month EBITDA remains fair, leading to a fair value of $ 34.

The bottom line

Airline is building an impressive fleet of freighters (it’s already the biggest lessor with a healthy margin), but the returns on investment have yet to materialize for investors as stocks generated double-digit annualized returns over the past three, five, 10 years, but have fallen behind the S&P 500 and the larger freight / logistics space during that time.

I still think the market will adjust to the value of the fleet that air transport is building, but it’s clear it’s a name that will require more patience and healthy, continued growth in demand for e-commerce / air freight.

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