Why the Alliance Aviation Services share price is grounded
I wrote about Alliance Aviation Services (AQZ) back in May 2023. Since then, almost every metric has improved except the share price.
The price has gone from $3.15 to $2.83 a fall of 10%.
Given it pays no dividends, that is a pretty disappointing return, especially when compared to the market return of above 16% for the same period.
Why is the Alliance Aviation Services share price so low?
So, if everything is soaring, why is the share price stuck on the ground?
Alliance is one of the most significant airlines in Australia with 72 aircraft currently in operation and firm purchase commitments in place to add another 20.
Its fleet increased by four aircraft over financial year 2024 and has doubled over the last five years.
Yet most Australians have probably not heard of them.
What does Alliance Aviation do?
That is because it operates few regular public transport flights and is reducing this still further.
Its strategic goal is to be a wholesaler of aircraft capacity. Its largest source of revenue is contract revenue which accounted for 48% of revenue in FY24.
This is typically in the form of contracts with mining companies where it flies mining staff from the major ports to remote mining locations. These are known as fly-in-fly-out (FIFO) workers.
Its second largest source of revenue is through wet lease agreements.
This is where Alliance owns the aircraft but leases them to Qantas and Virgin. In addition to providing aircraft capacity, it also provides the staff and takes care of all aspects of servicing the aircraft.
This side of the business has been growing rapidly and now accounts for 41% of total revenue. Wet lease revenue was up 63% in FY24 and flight hours increased 62%.
Alliance Aviation's business model is very different from most commercial airlines.
It currently have about 15 long-term contracts with clients. For example, it recently renewed its contract with Newmont for another five years.
It has been servicing Newmont since 2011, operating FIFO flights to the remote Tanami mine in the Northern Territory from Perth, Darwin, Alice Springs and Brisbane.
This means it does not carry the passenger revenue risk like other airlines do.
Revenue is steady and predictable. A lot of the costs are also factored into the contracts. For example, its FIFO contracts include the cost of fuel. This means its margins are not impacted by fuel price fluctuations.
What happened to Alliance Aviation being acquired by Qantas?
Over the past 12 months there have been a number of significant developments for the company.
Firstly, Qantas terminated its plans to acquire Alliance in October 2023. Qantas acquired just under 20% of Alliance's share in 2020.
Then in May 2022 it announced it had reached an agreement to acquire the remaining 80%. The Australian Competition and Consumer Commission (ACCC) spent 12 months considering this and decided to oppose it as it would substantially reduce competition.
While Qantas is no longer moving forward with its takeover plans, it still retains 19.7% of the shares on issue which could be a drag on the share price until its intentions are fully revealed.
Who is the Alliance Aviation CEO?
There was also a transition in the leadership structure.
Scott McMillan was previously the chief operating officer (CEO) and managing director (MD). He has remained as MD and will be focusing on strategy, corporate development and growth, but in March he handed over the CEO role to Stewart Tully.
Tully will be responsible for all the day to day operations. He has been with the company since 2015 and was previously CEO.
Thirdly, it announced in April that its existing loan facility with ANZ, which was due to expire in January 2025, has been extended for a further three years and also increased by an additional $50 million.
There have been further funding facility increases of $150 million since June, giving it a total loan facility of $487 million which will fund its capital expenditure program.
The full year results released in August revealed strong operational performance. Total revenue was up 25%. This was driven by the wet leasing revenue.
Earnings before interest, tax, depreciation and amortisation (EBITDA) increased 46%, and earnings per share (EPS) was up 66%.
Total flight hours increased by 39% and staff increased by 17%. All this growth is being facilitated by strong demand. As it brings on more capacity (aircraft) it is filling this demand and its asset utilisation is also increasing substantially.
Its strategy is to grow by expanding the Embraer E190 fleet. It entered into agreements to purchase 34 second-hand planes.
To date it has settled on 14, bringing its total fleet up to 72 aircraft of which 35 are the E190's and the rest Fokkers. It owns its fleet rather than leasing, which is in stark contrast to the recently collapsed Bonza.
A component of its strategy is to "part out" some of the aircraft. "Parting out" involves reducing the aircraft to its component parts, engines, undercarriage, and auxiliary power units.
Then either using these components for spare parts for fleet use (thereby reducing maintenance capex of the operational fleet) or selling to third parties, as part of its parts trading business.
Due to the strong demand for operating aircraft it has reduced the number of aircraft designated for parting out from 11 to seven and will utilise the other four in service.
Alliance has a Stockopedia Quality Rank of 85. This is supported by strong margins and profitability. The net financial debt to equity is 82% and this funds the asset base. About 68% of total assets is the carrying cost of aircraft.
It generates positive operating cash flow consistently which is generally fairly consistent with profits. It forecasts it will continue to generate positive operating cash flow for the foreseeable future.
Free cash flow has been negative since 2021 due to its program of buying aircraft to expand its fleet.
It will own the additional aircraft and expect a significant increase in cash flows once the acquisition program is complete, expected to be June 2026. At that point it intends to start paying dividends to shareholders.
Turning to its valuation, it is trading on a low forward PE ratio of 7. It does not currently pay dividends so is not attractive to income investors.
Airlines are perceived as risky businesses given its high capital requirements and the highly competitive nature of the airline industry.
This is front of mind given the recent demise of Bonza and Regional Express (REX) entering administration.
However, as explained above, Alliance's business model is very different from most commercial airlines.
If it can retain its competitive advantages, including high standards for safety and on-time performance, as well as successfully implement its growth strategy, it has the potential to generate strong cash flows and reward shareholders.
Disclaimer: The author has holdings in AQZ.
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