Buy Advent Air* at 12.25p
27 December 2006 (16:01:46)
Never Buy Airline Stocks says Warren Buffett
The Rudest Accountant on Earth (Robert Leach) agrees
But there is one airline stock you should buy - AIM listed Advent Air*
It has effective natural neo-monopolies and...
Long term contracts which give great visibility of earnings
It has cash and is generating cash and the shares are a buy at 12.25p at up to 14.5p with a one year target of 22p
I tend to agree with the two great investment minds of the 20th century (Warren Buffett and Robert Leach) - airline stocks should on the whole be avoided. On conventional routes in the Northern hemisphere profits are always eroded by competition and high operational gearing means that if there is a downturn in passenger numbers such companies fall into loss very quickly. Worse still most of the airlines we know are highly financially geared as well. All in all it is a sector I'd avoid and perhaps I am not alone and that is why the market has overlooked Advent Air* (AAIR) a company which listed on AIM in November 2005. It is not a conventional airline but a niche player with very secure earnings streams operating in Western Australia and the Northern Territories and it has been consistently cash generative and has a growing cash pile. The shares are a buy at 12.25p with a 14.5p limit buying price and a one year target of 22p per share.
Not a New airline
When Robert Leach railed against Advent Air on stockmarket-channel.tv his in-depth research lead him to believe that this is a start up company operating in Europe. As it happens the operating unit of Advent, Skywest, has been going for 46 years and operates only in the land of High Culture. When Advent floated it owned just 62% of Skywest but it has since bought out the minority interests and now has full control.
There are two main props to the Advent business. The first is the provision of services on long term contracts to mining companies in Western Australia. The only way for mining companies to get staff from their remote operations back to civilization (well, the Australian version of it) is by air. And thus large mining companies such as BHP and Rio Tinto sign long term contracts for Advent Air to supply such transport. This gives superb visibility of earnings. The second part of the operation is flying local services to and from Perth and Darwin to various smaller towns in west and North Australia and also up to Bali. The point about this operation is that these routes would not sustain intense competition - if you want to get to these places (I don't) then you really have to use Skywest. On around 60% of these routes Skywest has a monopoly.
So while Warren Buffett might hate conventional airlines what he really loves are unregulated natural monopolies because they give the owner pricing power. If fuel costs go up so do ticket prices. Skywest has complete ability to control its own margins and destiny. As it happens Skywest has a prudent hedging policy which means that it has a good chance of curbing fare increases.
Cash
Skywest owns outright a fleet of 7 planes and has a further three operating under lease. Although it depreciates its planes over 6 years they have a useful life of 20-25 years. The company estimates that its fleet in operation today has another 12-15 years in it. Typically it might cost around £1.5 million to purchase a new Fokker 50 (the type of plane Advent uses) or it can be leased for perhaps a third of that. This means that Skywest can hope to fund expansion of its fleet from cash it generates as it has a very high cash conversion rate. Hence in the year to June 30th 2006 although the pre-tax profit was only £1.32 million (based on sales of £32.8 million) if one adds back an (overly conservative) depreciation charge of £1.82 million one finds that the net cash generated from operations was actually £3.03 million. Hence Advent can both grow its fleet and also its dividend.
As it happens the company ended last year with net cash of £8 million (one third of the market value) and thus even if it were to buy two new Fokker's this year I would expect its year end cash position to be in excess of £8 million and next year (to June 30th 2008) similar capital expenditure and the dividend would still not be enough to see net cash grow to closer to £9 million.
Management
The key man behind Advent is CEO Jeff Chatfield who is plain speaking and pretty blunt. His focus is on growing his business, a business he knows well and he will not mess with fools who get in his way. He has had the decency not to mention the cricket so I shall refrain from making any more jokes about Australia
Current Trading and forecasts
The company has today announced its November passenger numbers. Overall passenger numbers rose by 11.57% over a year ago and capacity was up by 4.75%. This is a story of burgeoning demand in the buoyant Western Australian economy as well as of an expansion of the fleet and of the routes serviced. Advent has also, in recent weeks, announced the signing of two major new contracts with mining companies.
In the year to June 30th 2006 pre-tax profits came in at 4 million Singapore dollars (£1.33 million). Perhaps if profits were to be stated in pounds it might attract British shareholders in greater numbers? That equated to earnings per share of 1.05p. This year pre-tax profits should double to £2.7 million which equates to earnings of 1.3p. The earnings growth is flattened by a share issue to buy out the minority owners in Skywest. Next year I would expect earnings per share to come in at 1.5p-1.6p as Advent operates more aircrafts on more routes. Personally if I were running Advent, if the shares remained at this level, I'd be buying back shares to boost earnings but I sense that this on not on the cards. The company paid a 0.2p dividend last year and that should double this time and should hit 0.5p by next year.
Valuation
The net cash position should be £8 million at this year end or 4p per share. A growing business with largely protected margins should be trading on a low teens multiple if not more. Hence my 12 month target is based on a current (year to June 30th 2008) year multiple of 12 times earnings (12 times 1.5 = 18) plus cash (4p) equals 22p per share. With a modest yield as a bonus the stock is a buy at 12.25p with a 14.5p limit buying price and a one year target of 22p.
*Advent Air is a corporate client of RSH the ultimate owner of t1ps.com
