This week's Fairfax column delves into the airline world. Credit Suisse is frantically running around town trying to convince investors that an airline is actually a mining services play. In a way it is, getting its business from the big miners. But it can't change what it is...an airline!
Also, the portfolio is up now, so that is definitely worth checking out.
November 25, 2011 - 10:22AM
The mining boom manifests itself in many ways, and one small cap piggybacking it effectively is Skywest Airlines (ASX code SXR).
This week the Singapore-based airline said it had signed a charter contract with Bechtel, which is the design and engineer partner for the onshore gas plant at Chevron’s massive Wheatstone liquefied natural gas (LNG) project, off the coast of Western Australia.
This comes hot on the heels of the contract it signed with BHP Iron Ore earlier this month. And there is no doubt that the public backlash from Qantas management’s decision to ground its fleet will help it secure even more contracts.
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The group achieved sales of $S240 million ($189 million) in the year to June 30. UK-based broker WH Ireland forecasts revenues to grow by more than 25 per cent a year over the next two years. Skywest’s forecast earnings per share almost treble between now and fiscal 2013.
The broker is clearly excited about the “fly-in fly-out” business, where mining companies fly their workers from their homes in Perth or Bali to remote locations such as Karratha or Barrow Island for a couple of weeks at a time, where they stay in their donga, or hut.
And yet, at 40 cents, the stock has a market cap of about $80 million and trades on a PE of close to 7 times, a heavy discount to the market average PE of about 11 times. What’s going on?
Could Alliance turn out to be Icarus?
One broker probably not looking too deeply into the reason for Skywest’s big discount is Credit Suisse. Under the Radar understands that the firm is going to conduct a bookbuild early next week for one of its competitors, Alliance Aviation Services.
The airline is looking to raise in the order of $100 million, which would give it a market capitalisation of about $180 million. The money being raised is apparently being used to pay down debt.
But whether or not it is a success still hangs very much in the balance, judging by Under the Radar’s chats with various funds managers around town.
The pricing is based on a PE of 10 to 11 times, and this multiple is raising eyebrows.
The bookbuild process involves the broker working out the demand for shares at different price levels. So one investor might say it will take 5 million shares at 11 times, and 10 million at 10 times. It’s a sort of auction process where they attempt to get the highest price for the vendors.
As with any auction process there is a reserve. If they don’t get the book covered at 10 times, meaning they can’t sell $100 million of equity on the basis of a PE of 10 times, they might pull it.
Fly-in fly-out is obviously a growing industry in Australia, having “good tail winds,” as one fundie said.
Hard to make the numbers fly
Airlines are difficult places to make money, historically. But a positive of the fly-in fly-out model is that it is contract based and demand for its services don’t fluctuate to the degree that it does for consumer based airlines. Plus, they claim to pass on the cost of fuel and exchange rates.
A negative however, is that the return on capital is always going to be limited by the customer. Companies like Rio Tinto, Chevron and BHP are not going to just sit there and watch these operators make large profit margins, or returns. They clearly have much more power than the average Qantas passenger.
In the end, an airline is an airline. And who better to end the subject on, than the “Sage of Omaha” himself, which incidentally goes a long way in explaining not only the relatively low multiple of Skywest, but also the problem with investing in Qantas.
“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favour by shooting Orville down.”
— Warren Buffett, annual letter to Berkshire Hathaway shareholders, February 2008.