A rather unique case in the aviation industry

Hi,

I never bought this stock before today, as I considered it a bit expensive.
Obviously, I was wrong.

Even if it had some rerating before covid, I suspect that it was largely discovered by the market with Covid.
Their very steady business model (relying on FIFO) showed its resistance, while so many in the sector went bankrupt or needed the government support to avoid bankruptcy.
As a result, the stock which dipped from 2.67 $ in Feb 20 to 1.30 $ in March 20 recovered rapidly to 2.65 $ in May 2020.

Since then, the company went on the offensive to use the opportunities to buy aircrafts at low prices, given the market conditions.
As a result, they bought 14 Embraer E 190 in August 20, another 16 in December 20 and the last 2 ones in June 21.
This is significant, for them, as they had only 42 aircrafts at the end of FY 20.
As a result of these acquisitions (progressively deployed, mainly from FY 22) and still good results, the stock continued to increase to reach 4.40 $.

Yesterday, the company announced its results and I was quite surprised to notice that the valuation is still not high, based on its 2021 free cash flow yield.
Based on my calculations (using the underlying cash flow from operation and the existing fleet maintenance Capex*), the stock has a free cash flow yield of 4.6 %, which seems to me quite high, given the stability of its earnings so far (again due to their FIFO model).

Yesterday, Alliance Aviation announced that these acquisitions (32 E 190 aircrafts) will allow them to triple their capacity, in terms of hours.
Obviously, that's significant for them.

As mentioned@SouthernLad, the key is to successfully deploy this new fleet.
They just indicated that the largest part of the aircrafts (up to 18) will be allocated to wet lease contracts (mainly to Qantas, their main shareholder).

As a result, I tried to assess the potential valuation of the company today :
- looking at the earning potential with the new capacity,
- multiple that we should apply to the earnings potential.

By tripling their capacity, they probably could at least double their earnings capacity (simplistic assumption, I guess some other people here can probably get a better assessment).
At the same time, we know that most of the E 190 aircrafts will be allocated to a more volatile business (wet lease).
So, I think that the earning potential from the E 190 fleet should be valued on a much lower multiple.
I chose to take a PE of 10 x for this business, while I consider that their traditional business can be valued on a multiple of 20 x (in line with their PE 21).
If we take the assumption that all their new fleet will be deployed out of the FIFO business**, the earning potential could be valued at a PE of 15 x.
Overall, it would correspond to an upside of around 50 % for the stock between now and FY 23, when all their new aircrafts will have been deployed on a full year basis.

I do not consider this as an aggressive scenario, as this approach does not take into account the low price they have been paying for their recent acquisitions.
So, it is probably more interesting to look at ROE (rather than PE) as it also takes into account the price paid for the acquisitions.
Alliance Aviation has now a P/B of 2.2 x, which seems in line with their ROE 2021 of 12.4 % (using their underlying NPAT).
If they can double their earnings in the future, their ROE could also be at 20 %+, which could justify a much higher P/B. However, we have also to take into account that there will be more volatility in their earnings in that case, as they will depend more on the volatile wet lease business.

Once again, this is a valuation exercise and, by definition, it depends a lot on the assumptions we take.
For example, there may be much less competition in the future for the passenger business (as companies will try to restore their margins) which could justify a higher multiple than the PE of 10 that I used above.

* after taking into account the lease payment.
** in fact, it is more complicated, as at least 5 aircrafts are to be allocated to FIFO routes. But taking this assumption is also interesting as it is quite cautious.