Interactive Investor

Stockwatch: is it time for this small business to fly?

21st December 2021 12:50

Edmond Jackson from interactive investor

Our companies analyst believes the pandemic and its fallout could serve long-term prospects well.

Since last July, the £52 million small-cap aviation charter and services company Air Partner (LSE:AIR) has issued three profit upgrades in respect of its financial year to 31 January 2022. Yet at 82p, shares in the 50-year-old company remain low in its 150p to 50p sideways range since the 2008 financial crisis.  

Does this mainly reflect management guiding over-cautiously to start with, amid concerns that a viral pandemic must impact aviation? This would imply adjusting to a still-modest scenario. However, strong demand for private jets and freight may be sustained, and the group has also usefully diversified into safety and security.  

Several financial ratios also raise the question of whether a medium-term re-rating is due. 

Three possible macro drivers 

Aside from managements narrative, I speculate there are some macro considerations to think about. 

Air Partners private jet business (accounting for 32% of gross profit, which is the best performance indicator for this group) is capitalising on wealth extremes nowadays, where Covid has also driven a demand for exclusivity. Unless the global rich suddenly become environmentalists, such behaviour could stick.  

The freight side (20% of profit) has enjoyed exceptional boosts from Covid vaccines and testing kits, but this kind of work could persist for two years or more. Admittedly, though, it is a mixed story on the charter side (27% of profit) where tour operators and conferences/exhibitions remain below pre-pandemic levels. Omicron could sustain a medium-term disruptive effect just as central banks struggle to temper inflation, adding to the risk of stagflation. 

The groups growing safety and security firms (21% of profit) ought also to enjoy an aspect of support from regulation as a longer-term influence. 

Past credibility issue, yet sound underlying set-up 

It’s possible that Air Partner has a lingering credibility issue from a 2018 accounting scandal. Certain uncollected receivables were offset against deferred income instead of being expensed to the income statement. Totalling £4 million, this lasted from mid-2011 to early 2018, putting financial controls in doubt and leading to the CFOs departure. Yet a new broom from 2018 should have ensured a break with the past. 

The groups set-up is financially attractive. It is substantially a call centre” type operation requiring little capital expenditure, so strong free cash flow can push return on capital into the 20% and 30% ranges. The table also shows strong earnings per share growth from 2016 to 2019, giving an indication of what this business is capable of achieving.  

The 31 July balance sheet had no debt beyond £5.1 million of leases, whose net cost clipped barely 5% of interim operating profit. There was £9.8 million of cash separate from the £19.8 million of jet customerscash held.  

Admittedly, and despite this good cash profile, the board is not yet expected to re-rate last years 2.4p dividend beyond 2.5p this year and 2.6p in 2023.  

That implies a modest 3% yield – hardly a prop – but if the payout can be restored to around 5p a share, as was paid from 2017 to 2019, the stock should be trading comfortably over 100p. 

My sense is that the business setup raises the odds that this will happen in the medium term, the upgrades conveying a business with greater strengths than the market assumes.  

Be aware of a typically mixed operations narrative 

I have followed Air Partner on and off during its 20 years of listing and struggle to recall any time it has fired on all cylinders. Yet management has responded by diversifying into ‘safety and security’ with around four key activities. The first half-year to 31 July showed this division had yet to recover to pre-pandemic levels despite a 70% improvement in gross profit.

The table also shows operating margins varying between 2% and 12%. The first half-year achieved 11% in 2021, but it stood at 25% in the first half of 2020 when the annual outcome was over 12%.  

With the forward price/earnings (PE) possibly testing single figures, however, might all this be ‘in the price’? 

Cumulative profit upgrades imply annual revenue of at least £75 million in the current year to 31 January. Thus a market cap near £53 million means Air Partner is valued at 0.7x sales. Such a low ratio is logical only for a business on wafer-thin operating margins, so an element of mean reversion upwards in market value seems likely. 

If the groups current trading represents a core capability, then once the global economy picks up, Air Partners yield, PE and price/sales ratio should all benefit. 

Air Partner - financial summary
Year end 31 Jan

  2016 2017 2018 2019 2020 2021
Turnover (£ million) 49.9 42.5 74.3 77.5 66.7 71.2
Operating margin (%) 6.4 9.4 7.0 4.6 2.2 12.4
Operating profit (£m) 3.2 4.0 4.9 3.6 1.5 8.9
Net profit (£m) 2.3 2.5 3.6 2.9 0.3 5.6
Reported EPS (p) 3.8 4.7 6.7 5.4 0.6 9.3
Normalised EPS (p) 5.8 6.5 8.6 10.7 6.3 12.4
Earnings per share growth (%) 4.3 13.4 31.5 24.3 -40.7 96.7
Return on total capital (%) 23.4 28.0 30.3 19.7 5.7 35.7
Operating cashflow/share (p) 11.4 3.5 18.6 3.6 14.4 23.6
Capex/share (p) 0.5 0.5 1.2 0.9 1.7 0.9
Free cashflow/share (p) 10.9 3.0 17.4 2.7 12.7 22.7
Dividend per share (p) 4.9 5.2 5.5 5.6 1.8 2.4
Covered by earnings (x) 0.8 0.9 1.2 1.0 0.3 3.9
Cash (£m) 17.0 17.8 23.2 25.2 21.4 27.7
Net debt (£m) -13.5 -14.9 -20.7 -19.7 -1.6 -20.9
Net assets (£m) 10.2 11.0 11.4 11.7 9.2 21.1

Source: historic company REFS and company accounts

Firm progression of upgrades looks pretty sound 

The year to January 2021 enjoyed record profits due to freight demand during the pandemic; the first quarter of the current year then went well; momentum was established, so management expectations should not have been ultra-cautious. 

At Julys AGM, strength was reported both in US private jets and in chartering by governments, sports and the cruise sector. Overall, the company was trading well ahead of pre-Covid levels” – suggesting it was likely to beat management’s expectations for the full year to January 2022. 

Momentum was also starting to build in UK private jets which had recovered to pre-Covid levels. Freight was lumpy, having enjoyed a boost from Covid testing kits and vaccine raw materials that then fell back. Continental Europe remained challenging. 

A week later, Air Partner reported a 57% hike in global bookings for private jets over five months to end-June, with new members up 37% year-on-year. This was driven chiefly by wealthy people continuing to fly in the US. 

At Septembers interims, full-year expectations were guided higher a second time as underlying pre-tax profit rose by 27% to £3.5 million. Augusts acquisition of a leading emergency planning and incident response company was expected to be earnings-enhancing from the 2022 financial year, and to make a meaningful” contribution to group long-term performance. 

Then last Friday, profit for the full year materially” ahead of expectations was promised, though no quantification was provided. 

One problem is that although published consensus has shown £1.2 million net profit for an earnings per share (EPS) of 7.8p, this does not square with the 63.6 million shares issued. But if we do assume £1.2 million, this is a low target anyway.   

I still like the narrative that cites exceptional” freight bookings bolstered by vaccine transportation, plus continued strength in private jets whose demand has more than offset the challenging conditions in charter, and also the safety and security element.  

Am I over-optimistic to figure that as and when the global economy does pick up, Air Partner will perform more consistently overall? I cannot see private jet demand slipping back much. 

Risk/reward profile tilts attractively at 82p 

I suspect a recent drift from 94p in September largely reflects UK small cap being out of favour. 

Yes, there remain risks and Air Partner may retain generally more volatile revenues and margins than other businesses. Yet management appears to be making good progress to mitigate the challenges. Although I would not expect its stock to soar, this looks a good time to accumulate holdings. 

Living near Biggin Hill airport, I have witnessed a huge surge in activity, and that continues. However, the plethora of jet firmsoffices that have sprung up on its periphery shows this is a competitive market. 

I therefore sense a longer-term inflection point for this stock, to target recovery over 100p and in due course its pre-pandemic level of 150p. Buy. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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