Small Caps | Jul 27 2020
Alliance Aviation now has capacity to materially expand its fleet and exploit the current dislocation in the airline industry.
-Ability to exploit current opportunities
-Low risk for results on August 5
-Material fleet expansion anticipated
By Eva Brocklehurst
Alliance Aviation ((AQZ)) is in a unique position, one of the few airlines that has been trading profitably during the pandemic. A focus on the resources sector has allowed it to take advantage of elevated demand for chartered aircraft.
A recent capital raising has also provided capacity to materially expand its fleet over FY21-23, to cater to an expected rise in charter activity, a recovery in regular public transportation and wet lease services to other airlines.
Credit Suisse points out Alliance Aviation has made its most value accretive moves in times of maximum market dislocation, and for the airline industry there is no other description of the current environment.
The broker assesses the "numbers look good", as the company's cost of capital is lower and prices for aircraft have dropped. Factoring in depreciation, interest and an enlarged share count, Credit Suisse believes the equity raising/aircraft purchases will deliver an accretive outcome of around 17% to earnings per share relative to previous forecasts.
Ord Minnett, too, notes a structural change in the domestic aviation market, particularly in Western Australia and Queensland, and the company's focus on customer outcomes and nimble fleet management provides for a comprehensive opportunity.
Morgans understands market share gains have been strongest in Queensland, which is the region where the company generates the strongest margins. Geographically, the benefit from social distancing has been greatest in Western Australia, although the broker points out fleet expansion is not contingent upon a continuation in elevated activity levels from social distancing requirements.
The company has provided net profit guidance for FY20 of more than $40m, which Morgans notes is around 15% ahead of pre-pandemic estimates and comes despite the headwinds to inbound tourists services and regular transportation.
The broker envisages a low risk to results when the company reports on August 5 and initiates coverage coverage with an Add rating and $3.54 target. Morgans will focus on progress in converting new charter customers to long-term charter contracts and assess any update on the timing/scale of major fleet expansions.
Gearing has remained conservative and having recently raised $95.7m, Alliance Aviation has now significant ability to expand its fleet. Management believes increased capacity will be required to service the expansion in the charter division and provide the required flexibility to capture a recovery in general transport activity.
Brokers assume 15 planes are purchased and delivered into the fleet over FY21-23 which will result in an average operating fleet of 56 aircraft by FY23. The stock has re-rated recently but Morgans envisages further upside over time as a return on the fleet expansion is realised.
Ord Minnett calculates a price per aircraft of US$5m, with each plane expected to generate around $2m in operating earnings per annum that would allow a payback period of around 4.5 years, or less if planes are obtained at lower prices. Hence, 15 extra aircraft would add, therefore, around $30m to earnings.
The key lies with the multiple services Alliance Aviation provides, which include longstanding relationships with some of Australia's major miners and a reputation for reliable service.
The company has advantages in owning all but one of its aircraft along with a significant inventory of spare parts. There are also potential opportunities, given the likely acquisition of Virgin Australia by Bain, which is reportedly planning to reduce the fleet size.
The company's wet lease agreement with Virgin Australia is currently suspended. Morgans points out there is limited detail on the Bain strategy and a comprehensive proposal is expected prior to the creditor meeting on August 12.
Again, reports suggests Bain intends to operate Virgin Australia as a domestic carrier with a focus on Sydney, Melbourne and Brisbane which are routes that are not serviced by Alliance Aviation.
Bain has confirmed discussions with the company in regard to a potential partnership for regional Australia, stating it intends to retain original regional coverage through a mix of Virgin Australia-owned planes and partnerships such as those with Alliance Aviation.
Hence, Morgans suggests Alliance Aviation is well-placed to at least retain existing contracted wet lease hours once travel activity and demand recovers.
The main risk envisaged is a future reduction in the level of mining activity, as key customers are concentrated in mining and energy sectors. Moreover, a prolonged downturn in inbound tourism and regional activity could also have an impact.
Still the company has noted that a number of existing customers have requested additional services in response to changes in travel requirements and new services are likely to involve a range of sectors, including domestic tourism operators, tourism boards and regional councils.
FNArena's database has three Buy ratings with a consensus target of $3.66 that suggests 19.3% upside to the last share price.
See also, Up Up And Away With Alliance Aviation on May 21, 2020.
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