Description

Summary Investment Thesis

We believe Era Group Inc. (“Era” or the “Company”) (Ticker: ERA / $21.71) has significant upside (50%+) with substantial intrinsic-value downside protection (from Net Asset Value / Liquidation Value).  Era has been a victim of the broad energy services sell-off and investors have overlooked the Company’s stable revenue stream and high-quality asset base.  As the market comes to appreciate these unique attributes, we believe shareholders will be rewarded accordingly.  We see ERA as “the best house in a currently bad neighborhood.”

We’ll elaborate in more detail in this write-up, but the highlights of our investment thesis are as follows:

Era’s equity trades at a discount to the Net Asset Value of its helicopters.

• Based on analyses by multiple independent appraisers, the value of Era’s fleet and associated ground assets, less all liabilities, is greater than $33 per share (compared to a $22 stock) (50% upside).
• Helicopters are uniquely stable assets due to a vibrant resale market (many alternative uses in firefighting, emergency services, government, etc.), and their extraordinarily long useable life (>30 years).
  • For example, a mid-sized helicopter bought today for $20M could be sold for nearly $20M in seven years in part due to aggressive required maintenance and rebuild of the aircraft.
  • However, this asset would be carried on Era’s books at ~$14M (note: Era currently trades at 1.0x stated Tangible Book – so well below the economic value of the fleet.

There are “multiple ways to win” and for the stock to move higher.

• Utilization has been a headwind but management has contracts in-hand which will take effect over the next 12 to 24 months and provide a stair-step bridge to higher EBITDA.
• Existing operations in Brazil contributed zero EBITDA in 2014 but are expected to ramp up throughout 2015/16, adding incremental annualized EBITDA potential of ~$15M.
• In addition to improving utilization, incremental fleet deliveries have identified contracts and will add annualized EBITDA potential of ~$10M.
• Improved utilization in medium helicopters by redeploying into other geographies or alternative uses should also improve overall yield.
• Unlike many of its competitors, Era owns its entire fleet – this provides the opportunity to free up cash through sale leasebacks with aggressive lessors or through dry leasing into other geographies.  The fleet in Brazil is a prime candidate for a sale leaseback given these assets are on 5-year contracts.
• Era generated $78M of FCF before growth capex (18% yield) in the last twelve months, giving it ample resources to invest in new aircraft, repurchase stock, pay down debt, or complete tuck-ins.
• As a spin-off, Era is underfollowed; additional analyst coverage and broader understanding of the business should benefit shareholders.
• Any reversal in the overwhelmingly negative sentiment surrounding the energy space.

·    There are overlooked or misunderstood factors that should make ERA more attractive to investors when better appreciated.

• Era’s revenue is recurring, contractual, and uniquely stable for the following reasons:
  • Helicopters are a very small portion of offshore operating costs, but without the people they deliver, such operations can’t function.
  • 75% of Era’s revenue is related to production activities.  Once the capital investment has been made in offshore exploration and production infrastructure, marginal costs are typically less than $15/BOE – so, even in a low-price environment these facilities will still operate.
  • Era generates two thirds of its revenue from fixed “standby charges” (without flying a single mile).
  • Helicopters are leased on multi-year contracts which operators rarely (if ever) cancel (Era did not experience any cancellations during the Horizon/Macondo spill when Gulf production and drilling were dormant).
• As mentioned above, helicopters have extremely long usable lives and hold their value incredibly well.
• From a GAAP ROI perspective ERA screens poorly because of management’s extremely conservative expense policy (expensing 100% of maintenance capex).  But, Era’s ROI is actually quite strong.
• Unlike the expensive and risky basins located internationally, the Gulf of Mexico (where Era generates 65%+ of its revenue) is generally agreed to be highly attractive based on stability, maturity, and low lifting costs.
• Barriers to entry are high and competition is limited:
  • Platforms are typically too far offshore for boats to compete.
  • Customers require a long history of safe operations.
  • High capital costs and inability to get vehicles (must get in line of OEM production).
  • Ground bases and related assets are required.
  • Air Operation Certificates are difficult to attain.
  • Pilots and mechanics must be hired and trained.

What follows is detail on Era’s operations as well as further exploration of our investment thesis.

Brief Company Overview

Era was founded in 1948, and spun out of SEACOR (Ticker: CKH) in January 2013.  The Company is based in Houston, TX, and is one of the largest helicopter operators in the world, providing transportation services to offshore oil & gas platforms, primarily in the Gulf of Mexico.  Era generates approximately 80% of its revenue in the US, 8% in LATAM, 7% in Europe, and the small remainder in Asia.

Era owns and operates a fleet of 160 helicopters with an average age (weighted by capital) of four years.  The majority of Era’s helicopters (also weighted by capital) are extremely valuable “mediums” and “heavies” which are capable of far-offshore transportation and are customized for offshore transport (the highest industry spec).  These “birds” cost $20M – $35M to purchase new.  The Company’s stated goal is to achieve a 15% annual EBITDA yield on the market value of its helicopters.  With the current fleet, this goal implies roughly $137M of EBITDA generating power (15%*$912M).  We provide our own estimate of normalized run-rate earnings later in this write-up.    

Era operates 75% of its helicopters on master service agreements ranging from three months to five years, where it generates two thirds of its revenue from fixed fee “standby” charges and one third from variable flight hours.  On these contracts Era provides pilots, maintenance, and all other necessary operational activities.  The remaining 25% of Era’s helicopters are “dry leased” to other operators in international locations (e.g., Brazil) where Era effectively serves as a leasing company and is paid a high-margin recurring lease payment.  The Company views dry leasing as an attractive means to gain exposure to international markets while also boosting utilization and diversifying into an additional valuable earnings stream.      

The Case for Share Price Appreciation

We believe Era is the proverbial “baby thrown out with the bath water”.  Yes, energy services are out of favor.  But, in this case investors receive downside protection from the discount to NAV and there are a number of reasons that the stock will ultimately converge on intrinsic value.

1. Stable and defensible revenue stream.  As mentioned above, Era’s revenue is contractual and recurring (more than two thirds is from fixed standby fees), which gives us confidence that the Company will be able to demonstrate a unique level of stability throughout a challenging 2015.  According to management, Era generates meaningful margin on these standby fees and will be able to realize substantial profitability and cash flow even with minimal variable flight hours.  Further bolstering this stability, 75% of Era’s business is tied to production activities which are much less likely to be materially affected by the current oil price.  The marginal lifting cost of a barrel in the GoM is estimated to be in the low double digits per barrel, making it highly profitable even in today’s oil price environment.  This business model is very different than the drillers, water haulers, and other providers of oilfield services that are leveraged to exploration and operate on short-term contracts or on a day rate basis.  In summary, we believe Era’s revenue and earnings will hold up far better than the market is pricing in, even under the most draconian oil price environment.  This assumption has so far been proven out by the Q4 earnings call where we learned from management that in spite of the current environment and macro headwinds, Era has not taken any price cuts or contract cancellations.

2.     Identifiable path to EBITDA growth through improving utilization and expanding fleet.  As mentioned above, pricing and contracts have not been an issue for Era.  The primary driver of performance challenges has been utilization.  We believe the market is mistaking this company-specific utilization issue (which has been publicly known and is in management’s control and improving), for a more systemic pricing/volume issue.  In fact, management has shared approximate timing and earnings guidance for the impact of the incremental utilization improvement and new deliveries for 2015 and beyond.  Based on this information, we believe management’s commentary implies at least $25M of incremental annualized earnings power over the next 12 to 24 months, with the 2015 calendar year impact potentially in the range of $10-15M and the remainder delivered in 2016.  However, given the current market environment we believe delays are likely and therefore prefer to look at the Company’s “normalized run-rate” earnings power, rather than attempt to guess at actually what hits in CY15 vs. CY16.  As long-term investors we are more concerned with the ultimate earnings power of the assets in a normalized environment than we are with the exact timing of their realization.  Therefore, we are happy to wait for this incremental earnings power to materialize, because in the meantime we believe Era’s asset value and stable earnings base provides attractive downside protection.

• Brazil.  Era’s joint venture in Brazil has been a drag on earnings for the past four years as idiosyncratic fleet- and customer-related disruptions prevented optimal utilization.  However, Era has finally secured long-term contracts for the entire existing fleet (12 helicopters) and expects (according to management) the full run-rate financial impact to show up in Q3 of 2015.  In addition, the company is moving four highly valuable EC225s (heavies) to Brazil (one of which is incremental and three are renewals).  Contracts on these helicopters start in July 2015.  Lastly, the Company recently announced it is also bringing four incremental mediums to Brazil for January 2016.  All of these are on solid 5-year contracts.  We estimate the annualized impact of these contracts to be in the range of $17M of incremental EBITDA (what shows up in 2015 vs. 2016 is more difficult to predict).   
• “A handful of Mediums.”  Management has not provided exact clarity on the nature of its utilization challenges outside of Brazil (due to competitive reasons), but from conversations with management, we understand it is driven by a “handful” of mediums.  We are confident that management will be able to ramp up the utilization of these mediums via relocation, alternative uses, and more aggressive bidding (although not ideal to take a lower price, incremental dollars are highly accretive so the ROI is justified).  For conservatism, we did not include any incremental contribution from improved utilization of mediums in our EBITDA bridge below.       
• EBITDA bridge.  As discussed above, and based on contracts in-hand, combined with historical performance and management’s comments regarding the EBITDA “yield” on the Company’s assets, below is our estimate of normalized run-rate EBITDA potential.  Assuming that the Company’s existing contracts remain in place, we are able to chart a reasonable “stair step” path of improved utilization and capex-driven incremental fleet growth to arrive at normalized run-rate EBITDA of $115M.  Historically, forward multiples have averaged ~8.0x, but the estimate below would suggest Era is trading at 6.1x normalized EBITDA.  It’s also worth noting that due to the Company’s extremely conservative expense policy, in 2014 approximately $64M of pre-tax maintenance expenses ran through the P&L.  Management suggests these expenses are actually costs that could be capitalized (if not for their conservatism).  Adding even a portion of this back to EBITDA makes for an even more favorable comparison.

3.     Accretive returns on capital.  Era will continue to generate above-market returns on capital, which we believe should help the market to appreciate the “fair value” of the Company’s assets ($33 per share).  Era’s nominal GAAP ROE is muted by the impact of management’s conservative expense policy (expensing 100% of maintenance capex).  This leads Era to screen poorly with single digit ROE; however, the true ROE adjusted for this policy has averaged in the high teens or low 20% range.  Close competitor BRS has steadily compounded tangible book value per share at 10% over the past 23 years, and we believe Era can demonstrate similar economics.  We believe that a business of this caliber, with stable, recurring revenue and high-teens returns on capital should trade for AT LEAST the fair market value of the underlying assets generating these returns.  If the market ultimately comes to agree with us, there is more than 50% upside in the stock (at 1.0x NAV).  It is also worth mentioning that in better parts of the cycle these companies typically trade at a premium to their NAV (see BRS for example), which implies that in an up-cycle, Era could have close to 100% upside.     

Below is a summary of valuation metrics that we evaluated for our investment in Era.  As mentioned above, given the asset-centric nature of the business and the uncertainty around the current market, we feel that NAV/share is the most relevant at this point in the cycle, and we are happy to wait for normalized EBITDA to present itself over time.  We chose to omit an EPS valuation due to Era’s conservative expense policy which suppresses earnings and makes this metric less relevant.

Summary of Valuation Metrics

Downside Protection

When we discuss downside protection we are focused on the intrinsic value of the company/assets we are buying.  We are NOT claiming the stock can’t decline since stocks can do almost anything in the short-term.  As shown below, in the case of Era, we believe the market is giving us the opportunity to purchase high-quality assets at a significant discount to their fair value.  At $22 per share, we are buying $33 per share of helicopters, in addition to a high quality management team, a 60+-year operating history, multiple AOC certificates, an incumbent position in the most attractive oil & gas geography, and a long list of other intangible assets to which the market is ascribing zero value.

NAV Calculation

We confirmed the value of Era’s fleet by speaking with third-party professional appraisers, helicopter lessors, aviation advisors, and competitors.  While it’s possible for FMV to fluctuate in the short-term based on a small sample size of transactions, the long-term value of high-quality helicopters like Era’s is extremely stable.  As mentioned earlier this is due to helicopters holding value due to their maintenance/ rebuild attributes, a vibrant secondary-use market, and lastly, unlike certain industries (e.g., shipping, drilling, etc.), the helicopter OEMs are highly disciplined and maintain strict control over supply.  In fact, our primary diligence confirmed that OEMs have not increased their production rates and are not averse to deferring deliveries if necessary to maintain price. Furthermore, the ability to use helicopters across so many diverse industries helps to mitigate the risk of a supply glut forming (unlike drilling rigs which have one use, an offshore helicopter can easily be converted into firefighting, medical response, government, etc.).

Risks and Areas of Concern

• Is oil & gas sentiment all that really matters?
  • In the short-term, oil & gas sentiment will undoubtedly be a driver of share price.  However, our thesis does not require a reversal in sentiment.  We view the sentiment trade as an opportunity to acquire a high-quality business at a discount, and believe that over the long-term, Era will demonstrate its ability to generate stable returns through a cycle, and the market will reward shareholders accordingly.  We would also remind investors of the old adage that “nothing cures a low oil price like a low oil price,” and suggest that sentiment is likely to shift back in our favor at some point.
• Do contracts matter in this environment?
  • Our primary diligence suggests that in today’s market, every contract is negotiable.  However, our research also suggests that contracts provide an anchor on which to base negotiations and demand a minimal level of compensation or other concessions.  Furthermore, we are given significant comfort by the fact that Era has been through cycles before and realized remarkable customer stickiness.  As mentioned above, helicopters are a tiny fraction of operating costs, but a critical component of the job.  Customers are extremely wary of canceling contracts because helicopters are frequently then relocated to other geographies and may not be available when demand snaps back.  Therefore, customers would rather pay the small (in comparison) cost of keeping helicopters on standby.  This was proven out during the Horizon spill where activity literally ground to a halt but not a single contract was cancelled.
• Will rates compress even if contracts stay intact?
  • During the 2008/2009 recession and the Horizon spill, Era did not experience rate pressure.  However, our primary diligence and recent commentary from competitors suggests that some customers may push for cost savings in this market.  That being said, the most likely area of focus will be reducing variable flight hours as opposed to cutting fixed standby fees.  This scenario is highly favorable for Era because, as mentioned earlier, Era generates a substantial majority of its cash flow and earnings from fixed fees, with variable hours only modestly exceeding variable costs.

In Closing

Era is an asymmetric investment opportunity where investors are protected on the downside and have multiple ways to realize upside:

Downside Protection from Discount to NAV

• Trading at 30%+ below liquidation value.

+ PLUS +

Multiple Ways to Win

• Demonstration of recurring revenue and earnings stability.
• EBITDA and FCF generation / strong returns on capital.
• Ramp-up of Brazil contracts.
• Improving utilization of mediums and driving EBITDA through incremental fleet growth.
• Sale leasebacks or other monetization of 90%+ owned fleet.
• Additional analyst coverage and broader understanding of highly defensible business model.
• Share buybacks or acquisitions of smaller competitors.
• Potential M&A target.
• Oil & gas sentiment shift.

= EQUALS =

Very Attractive Risk/Reward

• Limited intrinsic value downside with 50%+ upside.

Catalyst

See "Multiple Ways to Win" above