Air Transport Services Group (ATSG) supplies mid-size freighters, either providing a lease of the aircraft alone or on a packaged ACMI (Aircraft, Crew, Maintenance and Insurance) basis. They are the global market leader in their niche and the majority of their fleet are 46 Boeing 767-200/300 planes. For an overview of the company and their financials this presentation from the latest annual meeting of stockholders is a good start. Some quick valuations stats from Yahoo Finance:
Last Price: $3.46
Shares outstanding: $64.17M
Market Cap: $222M
Enterprise Value: $556M
Trailing P/E (ttm): 5.31
Price/Book (mrq): 0.74
EV/EBITDA (ttm): 3.30
While the company is trading at a discount to book value the various metrics related to earnings are the biggest attraction. Especially if you look at free cash flow ATSG appears to be extremely cheap. See the table below for the numbers of the past few years:
Roughly $100M in FCF for a company with a $222M market cap looks amazing, right? Wrong! There is one big problem: the maintenance capex is not sufficient to maintain the earnings power of the business since planes have a limited life expectancy, mainly due to metal fatigue that develops in the fuselage and wings. Air Transport Services usually buys used passenger planes and converts them to a cargo plane. It’s currently in the process of converting a number of new planes and the company expects that it will be able to use these planes for 15 years after the conversions are done. This explains the high capex from the past years, but this is not all growth since old planes are replaced at the same time.
I think a better proxy for how much FCF the company is truly generating is to take CFO minus depreciation and amortization. If the estimates of the company with regards to the useful life of the planes are reasonable accurate this should provide a decent approximation of the ‘owner earnings’ of the business. This gets us the following picture:
Since the company reports a lot of D&A this measure paints a completely different picture. Instead of an almost 50% FCF yield we get a more normal yield of ~14,0% (based on the TTM, and the average based on the past 4 years would be almost the same). This even a bit lower than the earnings yield that is currently sitting at 18,8%.
These numbers still look pretty decent, but I think there are some other issues worth mentioning. The company has significant post-retirement liabilities on the balance sheet: there is a defined benefit pension plan that is underfunded for $161M (total assets ~$595M). I really dislike seeing a company with a big defined pension plan because if the plan is unable to meet the, in this case, 6.75% expected return on plan assets shareholders will have to make up the difference some time in the future.
Another issue is that the debt (currently $357.8M) of the company is understated. While they own most of their planes they also use operating leases for a small part of their fleet. They had $76M in minimum lease payments outstanding at the end of 2011, and if you would capitalize this the EV/EBITDA multiple is going to look (a bit) less attractive.
What I also don’t like is the extremely low insider ownership. All directors and executive officers as a group owned just 2.4% of the company at the date of the latest proxy statement. That means they own a bit more than $5 million worth of stock. The CEO earned more than $2 million last year while the other executive officers earned on average ~$0.7 million. I think people generally do what is in their best interest and maximizing shareholder value is probably not going to be on the top of the list for this group of people…
I think it’s obvious that I don’t really like ATSG so far, but that doesn’t mean that it is necessarily overvalued or a bad investment. Maybe the company deserves to trade closer to book value, or maybe the current PE-multiple is on the low side. I don’t think there is a big margin of safety though at current prices. There is a lot of leverage at work, and the company is quite sensitive to changes in the economy. As an equity investor you would need a relative high expected return to compensate for these risks, so I don’t think that the company is significantly undervalued at the current price levels.
What do you think?
Word on the street is that there are some mistakes in your depreciation analysis!
Though to be fair I don’t understand why.