Cube Report (21 Dec 2020) – US bid backs aviation recovery #SIG

Cube Report (21 Dec 2020) – US bid backs aviation recovery #SIG

Good morning, it’s Roland here with the Cube Report.

Covid-19 is dominating the headlines and market movements again today, thanks to the new and more infectious variant of Covid-19 that’s spreading through the UK. Over the weekend, London and large areas of the south east were moved into new tier 4 lockdown restrictions, resulting in the closure of the hospitality trade.

A number of EU countries have closed their borders to visitors from the UK and France has closed the channel ports to accompanied traffic from the UK. I’d guess that if the situation isn’t resolved quickly, we might see some shortages of perishable goods in UK supermarkets.

Against this backdrop, the UK has yet to secure a Brexit deal (or not).

Shares in airlines, hospitality firms, housebuilders, retailers, and UK banks are all sliding today. Personally, I wouldn’t let the current situation alter my view on any of these firms. As far as I can see, nothing has really changed from two weeks ago — the vaccine rollout means there’s light at the end of the tunnel, but we face a difficult period in the interim.

I expect January and February to be very tough and wouldn’t be surprised to see the market pullback. But I remain positive on a six-month plus view.

At least some institutional investors are taking a similar approach. Aviation services firm Signature Aviation has attracted a takeover bid at a level that values the business at pre-pandemic levels. Today I want to take a look at this FTSE 250 stock, which Graham and I have covered several times this year.


Signature Aviation

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Market cap £3.1 billion
RNS Update on possible offer
Writer disclosure No position

Investing in suppliers of picks and shovels has always been the most reliable way to profit from mining booms. Perhaps a similar argument applies in aviation.

Signature Aviation provides ground services at airport for many airlines. The group’s operations are heavily weighted to the North American market, which accounts for 160 out of 222 locations. This bias has turned out to be a fortunate this year, as US domestic flying has recovered much more quickly than international flying. By October, Signature says that US flight activity was at 80% of prior year levels.

Takeover offer: Signature has received a bid worth $5.17 per share (386p) from US private equity group Blackstone. The offer is said to value the business at 14.9 times 2019 adjusted EBITDA — my sums suggest that’s equivalent to an enterprise value of around $5.2bn. Signature’s board would be “minded to recommend” a firm offer at this level.

Interestingly, it appears that Blackstone has been pursuing Signature since February 2020. This is the sixth proposal. We don’t know how low the bidding started, but I’m impressed to see that Signature’s management held their nerve through the worst of the US lockdown. Their confidence has enabled them to secure an offer which values the stock at a level last seen in August 2019. Essentially, Blackstone is willing to pay a pre-pandemic price for the business. This suggests they see air traffic returning to pre-pandemic levels quite promptly, especially in the US. That’s a view I’d share.

My view: Prior to the pandemic, my view on Signature was that it was probably a decent business, but quite highly leveraged and expensive given its average profitability (c.7% operating margin). I now feel was wrong on two counts.

Firstly, I underestimated the value of this group’s historically strong free cash flow and sizeable US footprint.

Second, I didn’t consider that US domestic air travel, which accounts for the majority of flying, would recover so much more quickly than international flying.

Congratulations to holders who kept their nerve/did their research and sat tight this year.


I don’t see much else in the midcap universe that’s worthy of note today, so I’ll sign off for now.

As ever, thanks for reading and all the best for the festive season.

Roland

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    Good evening Roland,

    What do you think in terms of possible takeover targets in the aviation sector with low valuation (probably below book)? I am thinking here of Air Partner (AIR) and Avation (AVAP). Both have been languishing below book value for the last few years even before COVID

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      Hello Whitebeard,

      I’m not in a position to offer advice on individual stocks, but my perception of Air Partner and Avation is that they’re probably decent businesses. However, my view is that valuing them correctly might not be easy. I agree that both have often appeared cheap, but I think there might be good reasons for this. Two major factors I’d consider when assessing value are cyclical risks (both stocks) and debt (AVAP).

      Re. AVAP & debt: As an aircraft lessor, Avation uses a lot of debt. This highly-leveraged structure means that a small impairment in the value of the firm’s assets (aircraft) could result in a much larger reduction in equity book value. For example, the latest accounts show assets of $1.4bn and total liabilities of c$1.2bn. Balance sheet equity is shown as $220m. My sums suggest that a 5% reduction in the value of the company’s aircraft could reduce the book value of AVAP’s equity by around 25%.

      For this reason, I think that an equity investment in Avation is effectively a bet that the firm’s existing leases will continue to perform and that its ability to borrow on attractive terms will be maintained. Forming an expert view on these areas is beyond my pay grade, at least without a lot of research (which I haven’t done). However, I think this might be one reason why the stock has often traded at a discount to book value.

      Regards,
      Roland

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