November 26, 2020 - 7:05pm EST by
2020 2021
Price: 3.87 EPS 0.12 0.17
Shares Out. (in M): 542 P/E 32.1 22.7
Market Cap (in $M): 2,096 P/FCF na na
Net Debt (in $M): 228 EBIT 90 120
TEV ($): 2,327 TEV/EBIT 26 19

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Summary of ENAV Thesis

ENAV is the only publicly traded air traffic control service provider in the world and we believe ENAV is an interesting way to gain exposure to a travel recovery, notably leisure, without having to take a lot of traffic volume risk. We think that as we move further away from the depths of COVID and closer to regulatory finalization in mid-to-late 2021, it will become more and more apparent that the earnings power of the business is very much intact. This clarity will coincide with the timing of vaccines released to the general public and coincident travel volume recovery, providing two catalysts to drive down the cost of capital imbedded in ENAV’s current stock price back towards its pre-COVID level. We think €5/sh or 20x 2023 FCF is very achievable in the next year (30% upside) and a 3-year IRR in the low-to-mid teens (%) range with dividends – an attractive return for an infrastructure asset with volume protection. Simply put, we anticipate ENAV will go back to being a boring, stable cash flowing machine that continues to provide mission critical services and that COVID will be treated as a once in a lifetime event.

There are two dynamics that have driven ENAV’s stock to where it is. One is obviously COVID and its impact to air travel. The second is a delay in finalizing regulations for the next tariff period (2020-2024) due to the historic volatility in air travel and the fact that the regulators want to have more clarity on the trajectory of the volume recovery before finalizing anything. This regulatory discount, in our view, is overblown based on both what the regulators have said and based on our discussions with industry participants. If anything, based on our dialogue with industry participants, there’s a view that the profitability of air traffic controllers could be stronger post COVID than before due to operators taking a much more aggressive look at efficiencies than before. Once we get to mid-2021 (May) when the regulatory picture will largely be etched in stone, it will become more apparent that 2022 will start looking more normal and the FCF generating power of the prior several years leading up to COVID of €130m or so will likely reoccur around 2023 and on.

While we are not giving ENAV credit for this in our valuation over the next couple years, we think that there is a lot of cost takeout opportunity (consolidating air traffic controllers from four to two, utilizing technology to keep reducing overhead, etc) and opportunity to deploy excess free cash flow into related non-regulated activities at very attractive multiples of earnings versus where the company has historically traded.

Given the nuanced nature of the business, we will spend a disproportionate amount of space simply describing what ENAV is, how they make money and how they are regulated.

ENAV Overview

ENAV is the 5th largest Air Navigation Service Provider (ANSP) in Europe and has been the top performer among European peers for performance quality since its IPO in 2016. ENAV is the sole provider of air traffic control and navigation services in Italy entrusted by national law without time limit. This is unlike most other European infrastructure companies that have finite lives on their concessions. ENAV is in a solid position to capitalize on travel to and from Italy and over Italy (ie Middle East and the Mediterranean region) when travel resumes.

ENAV has two regulated revenue streams that comprise the vast majority of the business – en route (75% of total) and terminal (25% of total). En route services involve the handling of air traffic crossing Italian airspace managed from 4 Area Control Centers located in Brindisi, Milan, Padua and Rome. The company has a diverse customer base and 80% of ENAV’s en-route traffic is international or over-flight (aircraft fly over airspace without landing), limiting exposure to potential softness in the Italian economy. Terminal services involve assistance during the phases of approach, takeoff and landing from 45 Control Towers located throughout Italy and is divided into 3 charging zones.

Regulated revenue is a function of charging the users of its airspace a tariff on the volume of airspace used. Traffic volume is expressed in service units (SUs), which are a function of distance travelled x weight of aircraft for en route services and just aircraft weight for terminal services.

Eurocontrol, the Eurozone’s airspace network manager, collects this “regulated revenue” on behalf of ENAV and other air navigation service providers on a monthly basis. Eurocontrol is able effectively to ground airline operations for delinquent payment which has historically resulted in even distressed airlines prioritizing amounts due to Eurocontrol above all else. Without payments to Eurocontrol (and ENAV), an airline has no operation.

It’s a solid business model that is experiencing a delay in regulatory approval for the next 5 year period due to travel volume volatility. This temporary hold-up / element of regulatory uncertainty is creating an attractive 3 year IRR opportunity for a longer-term stable infrastructure asset.


Deeper Look at Regulated Revenue Generation

The majority of regulated revenue is protected on a largely cost-plus model so the cash flows of the business should be relatively consistent again once the new regulation is finalized and tariffs are matched to the new volume trajectory. ENAV’s revenues are based off of determined costs (opex + D&A + cost of capital) and traffic revenue volatility is largely hedged through mechanisms discussed below that provide for revenue capture in future years if traffic volumes fall below plan.  ENAV has been building up a lot of this recoverable “balance” in 2020 and it will result in a big jump in cash flow in the 2023-2027 period when 85% of the balance is recovered. ENAV will produce record FCF during this period. We expect that approximately 80% of ENAV’s current market cap will be generated in discretionary FCF over the next decade as a result of this balance recovery + strong underlying FCF.

En-route services (75%% of regulated revenue)

ENAV is the sole provider of air traffic control and navigation services to all air traffic passing through Italian airspace. En-route services are defined as any traffic flying crossing Italian air space, with or without a stopover at an Italian airport. En-route traffic volume is expressed in terms of service units (SUs), which are a function of the distance travelled x weight of the aircraft. En-route traffic is made up of the following three categories:

International commercial traffic (41% of 2019 SUs) – flights with a point of departure or arrival at an airport within the Italian territory.

Commercial overflight traffic (41% of 2019 SUs) – flights over Italian air space without a stopover at an Italian airport.

National Commercial traffic (18% of 2019 SUs) – flights whose point of departure and arrival is within the Italian territory.



Terminal Services (25% of regulated revenue)

Terminal Services assist during the phases of approach, takeoff and landing within a radius of 20km of the runway and ENAV carries out this service from 45 airports across Italy. Traffic volumes (SUs) are only a function of aircraft weight at terminal services vs weight x distance at en route. Terminal services are ~2/3 international travel and ~1/3 national travel.

There are three charging zones, segmented by the amount of traffic they handle. Each zone subject to a different set of regulations but they largely emulate those of en-route:

Terminal Zone 1 (5% of 2019 regulated revenues) – airports with more than 225,000 movements annually. Rome Fiumicino is the only airport in ENAV’s network in Zone 1.

Terminal Zone 2 (7% of 2019 regulated revenues) – airports between 70,000 and 225,000 aircraft movements annually. Milan Malpensa, Milan Linate, Venice and Bergamo airports are in Zone 2.

Terminal Zone 3 (13% of 2019 regulated revenues) – airports with less than 70,000 aircraft movements annually. There are 40 airports and 4 Italian air force bases in Zone 3. Zone 3 is different in that it’s subject to the national regulatory framework from ENAC and provides for full cost recovery.



Tariff Build-Up – Cost Plus with Traffic Volatility Protection

To establish the applicable tariff to be charged for each area of operation (en route, Terminal Zone 1, Terminal Zone 2 and Terminal Zone 3), ENAV submits a detailed breakdown of the planned costs (determined costs) associated with each service for the regulatory period based on the regulators view of traffic evolution over the period. Costs include personnel, other operating costs, D&A as well as a European Commission agreed to cost of capital (around 9%-10%). There are also costs not directly associated with ENAV (non-ENAV determined costs) related to regulatory agencies (ITAF and ENAC) that are also submitted, but are basically passthrough. The final cost component is a revenue stabilization mechanism called the balance reversal. It partially offsets variance between planned vs actual traffic, planned vs actual inflation, and bonus/malus component in order to incentivize quality and capacity targets. The formula is basically ENAV Determined costs (Labor + Other Opex + Eurocontrol costs) + D & A + Cost of capital (9-10% WACC) + Non-ENAV Determined costs (ITAF + ENAC) = Total Determined Costs + Balance Adjustment (if necessary) = Chargeable Costs. The ultimate tariff charged for each operational area is Chargeable Cost / Planned Service Units for that operational area. This has historically and was expected to continue (pre COVID) to result in a high-teens EBIT margin.


The determined unit cost (determined costs / planned service units) profile is established at the beginning of each regulatory period and remains fixed throughout (the reason regulators want to have a better understanding of the traffic trajectory coming out of 2021 before finalizing), while the applicable tariff is adjusted in November of each year. The balance (traffic, inflation and bonus/malus) accrues in the reference year but the cash element is only collected in year N+2 through the applicable tariff adjustment. Given the magnitude of the balance build in 2020/2021, this recovery will spread over the 2023-2027 period and ANSPs have agreed to a 15% haircut as a token kindness gesture.

This “balance” framework limits both upside and downside risk associated with traffic, inflation and operating expense variance vs. projections over the course of the regulatory period. With respect to en-route services and Terminal Zones 1 and 2  (~50% of terminal revenue), ENAV bears full traffic risk within a band of +/- 2% of forecast. If variance extends beyond 2% to 10%, ENAV bears 30% of the risk. Anything above 10% and there’s no risk to ENAV. As a result, risk is capped at +/- 4.4% vs projected en-route traffic. For Terminal Zone 3 (other ~50% of terminal revenue), ENAV bears no risk associated with any variance from planned traffic. With respect to operating expenses, ENAV bears risk for all variance at airports that see 70,000 movements or more.