Air Transport Services Group, Inc. (ATSG) will exit 2017 trading at a low double digit Free Cash Flow yield,
which is a valuation more in line with a stagnant business or one benefiting from low rates (ie overearning
in the cycle). However, the Company continues to grow top line, win new business from marquis
customers, capture synergies across its platform, and should benefit from higher rates due to a current
pension fund deficit (which would be substantial increase to earnings). Simply put, ATSG is going long e-commerce growth.
Air Transport Services Group, Inc. (ATSG) is a holding company whose principal subsidiaries include an
aircraft leasing company and two independently certificated airlines. The Company provides airline
operations, aircraft leases, aircraft maintenance and other support services primarily to the cargo
transportation and package delivery industries. Through the Company's subsidiaries, it offers a range of
complementary services to delivery companies, freight forwarders, airlines and government customers.
The Company has a fleet of +60 aircraft (primarily 767-200s & 767-300s).
ATSG has historically been a cash-generative aircraft leasing company with very deep business ties to DHL.
Cash generation was typically redeployed into new aircraft purchases, which is converted for use as a
cargo aircraft. In March 2016, ASTG announced a game changing deal with Amazon, which included 20
leased and operated 767 freighters and warrants to enable Amazon to acquire up to 20% of ATSG
(warrants through 2021). ATSG will have all Amazon aircraft operational by mid-2017; the Company has
12 767-200s / 767-300s currently in service for AZMN.
ATSG is continuing to transition to longer term leasing (versus a less steady charter business line), and is
actively redeploying its FCF into accretive new plane purchases for cargo conversion and share repurchases (recently
announced a $50mm share buyback). The business should conservatively generate
a $300mm run rate on EBITDA in 2017 based on in-place plane deployments (implying a ~5.8x EBITDA
valuation based on increased debt). Perhaps more importantly, AMZN’s entry into the aircraft business is clearly part of a larger
internal goal to better control its own logistics and capture some of that excess margin. As such, we are
investing in a business at a 10-15% FCF yield appears very attractively placed given its new relationship
with AMZN which we believe should lead to years of growth.
Furthermore, the Company is now expanding through potentially important JVs. Notably, ATSG plans to
enter into a new JV in China in 2017 and recently announced the acquisition of PEMCO World Air Services,
a complementary business to its own maintenance and engineering services that effectively allows the company to vertically integrate its operations.
As a note we believe higher interest rates will help the company; yes, ATSG is modestly levered at ~2x, however we believe the combination of pension offset and hopefully shrinking the possibility of new entrants to a market due to higher interest costs will be beneficial to ATSG.
We believe the earnings release last night further confirms our thesis. The $300mm run rate exiting 2017 is well above the street, and more importantly we believe this points to management's strong understanding of both what the market "wants to hear" as well as a focus on ROICs and the positive read-through impact of growth capex spending.
Our best historical investments have been ones like ASTG, where we feel the company has a large addressable opportunity to put capital to work at strong ROICs. We believe exiting next year, using reasonable FCF Yields (~8%), the company can exit this year trading closer to $23 a share which would be closer to a mid 7x EBITDA metric. Given the ties to Amazon and the prospects for e-commerce growth, we view those multiples as reasonable and perhaps overly conservative.
Interest Expense: $24mm
Capex + Aircraft replacement/refresh: $115mm
FCFE (No tax due to NOLs): 154mm = $2.27 a share
Share count: assumes full impact of Amazon warrants (using treasury method)
Using the numbers above but assuming a 20% tax rate (cheaters short hand to guessstimate potential tax changes/NOL benefit and state taxes shoudl get us about $1.81 in FCF per share/8% = $22.70, we prefer to use this lower price per share as otherwise one has to believe the company will start to see significant multiple expansion (which the market may start to believe if they show they have a very large runway for compounding their capital..pun intended).
Risk Factors - Company specific i.e. ex global growthany
1) Major customer risk - While the company has been diversifying its customer base, it still does have major customer exposure to DHL and to Amazon and neither of these should be taken lightly. While in our view Amazon taking a 20% stake in ATSG is a view towards locking up part of their logistics chain, a more cynical view is Amazon demanded the warrants because frankly ATSG would give it to them.
2) Plane choice - ATSG specifically chooses to fly 767s as opposed to larger aircraft which may put them at a disadvantage in further negotiations.
3) Labor issues - One of the reasons Amazon doesn't necessarily want provide crew outright (wet vs. dry lease) is labor issues (which ATSG is dealing with currently); ATSG pilots hae already caused one work stoppage and continued problems in this arena may make them an unreliable partner.