Description

Long Alliance Aviation Services

All values are given in Australian Dollar.
There is a low amount of liquidity in these shares. The Top 20 shareholders owned a little under 95% of the outstanding shares according to last year's annual report.

This is again another write-up of an Australian mining services company.
In a way, Alliance is unique in that it has respectable earnings power (even in this downturn), while also having asset protection which is unrelated to the mining industry.

Alliance mainly provides FIFO services to Mining companies in Australia. In the past, about 15% to 25% of its revenue was not related to mining (charter and wet-lease to corporations and government bodies). This percentage has gone down dramatically the last 2 years primarily because management decided to focus more on the FIFO business. These FIFO contracts are long term contracts with a high amount of revenue and earnings visibility coupled with a provision for eventual price fluctuations for fuel, wages, etc... This stability and earnings visibility was something they did not have in their charter and wet-Lease contracts.
Recent turmoil in the energy and mining sector, the 2 biggest customers of these FIFO contracts, has put some of this revenue (and thus earnings) predictability under pressure. Management is therefore reconsidering diversification into the charter business to provide some stability against this volatility. A recent contract win to provide charter flights for tourists in Australia and New-Zealand accentuates this versatility.
The fact that Alliance can quite easily diversify parts of their revenue base makes it quite flexible in the face of this uncertainty.

Asset Value:
Around December 2014, Alliance had about 220 Million in aircraft on its books. Combined with aircraft inventory the asset value ends up to around 245 Million. There is a leasing liability against 1 aircraft, which amounts to around 1 Million. Net debt at that time was 95 Million and currently the company spots a market cap of just over 50 Million. In essence, you are buying aircraft and inventory for around 60 cents on the dollar. During December, an party hired by the financiers did an independent valuation of the aircraft and confirmed the carrying value of the aircraft.

Impairment of Aircraft carrying value and earnings power:
Big was the surprise when Alliance did an impairment of assets in their February half year report. In total, they wrote down around 40 Million in aircraft value, across all aircraft. The reason for the impairment however was altogether different. In accordance with the accounting standards, they found a more appropriate asset value for the aircraft to be 182 Million, about 40 Million less than the previous carrying value.
The applied discount rate to get at this asset value was a 15% pre-tax rate on the projected future operating cash flows. Since the Australian corporate tax rate is 30%, and a big part of this cash flow comes from the depreciation of assets, this makes for a juicy 11-13.5% cash flow yield. This yield is on the book value, and currently Alliance is trading around 4/10ths of book value.

The other valuation metrics are also eye watering. Besides the aforementioned P/B of 0.4, it has a PE of 5, a forward PE on underlying operations (there will be a lot of 1 off items in this year’s annual report) of 4 and an EV/EBITDA of slightly over 3.

A recent sale of 2 aircraft (while indeed not representative of the whole fleet) was done at prices above book value. The news release mentioning the sale of these aircraft refers to the fact that this sale reaffirms the valuation done by the independent advisors done around December 2014, before the impairment.

Long term contracts
Because Alliance is engaged in long term contracts with miners for an essential service related to their operations; Alliance has been a pretty stable business in both earnings and revenues. Most of these contracts are made with some of the lowest cost producing mines in the world, with long mine lives, across a diverse range of commodities going back for many years.
The biggest of these contracts are:

Oz minerals: Prominent Hill (contract duration not specified, mine life until at least 2018)
BHP:
- Groote Eylandt (contract until Dec 2017, with a longer mine life)
- BHP Iron Ore (contract until May 2019, longer mine life)
- Nickel West (contract until May 2017, longer mine life)
- Cannington mine (contract duration not specified)
- Olympic Dam (contract duration not specified, long mine life))
Rio Tinto: Argyl diamond mine (contract duration not mentioned, mine life until at least 2020)
Xstrata Copper: Ernest Henry mine (contract to Okt 2015, mine life until at least 2026)
Newmont mining: The granites mine (contract to Nov 2017, mine life until at least 2020)
Incitec Pivot: Phosphate Hill (contract to Jul 2018, long mine life left)
Newcrest Mining: Telfer mine (contract to Okt 2016, mine life until at least 2023)
Serco (gas QCLNG): Miles (contract details and duration not mentioned)
Santa Barbara ltd: Leonora Mine (contract details not mentioned, mine life until at least 2024)

As shown, all mines mentioned above are world class and/or low cost mines with pretty long mine lives.
I believe that management is selective about its customers, since I haven't seen any mention of a mine ceasing operations or an unpaid claim against a company.
These mines are also pretty remote, making FIFO the only viable way to get employees in and out of the mining camps.

Operationally:
Alliance has a very focused strategy. They directly own all but one of their aircraft (1 Fokker 50 is leased with a purchase option, which will probably be returned to the owners in the near future) and operate aircraft of only one manufacturer, namely Fokker. Management believes this provides them with both organizational and operational advantages. Some of these are lower maintenance costs (which they do mostly in-house) as well as training and other personnel costs. A similar strategy is employed by many low cost players in commoditized businesses (Ryanair is one of the clearest examples).
All the competitors in the space own a more diversified fleet.

Comparables:
Only 1 comparable company (a pure FIFO services provider) was listed in the past, Skywest Airlines, which was taken over by Virgin Australia in 2013. Skywest had higher costs, lower profit margins (about half as low) and even started making a loss in their last half year as a listed company when the resource boom started turning into a bust. Alliance on the other hand has always managed to make a profit before special items and still does.
Qantas has also taken over a private competitor in 2010 (named Network Aviation). While no complete financial statements have been released by this company, a 2011 Qantas annual report mentions that the company only managed to break-even during that year.
Operationally, this company appears to be run a lot more efficient than the competition which is evident by its big margins compared to other airlines.

Management is also very effective in operating the fleet by having very high “On Time Performance” percentages of around 90-95%, higher than most in the industry. This is pretty important given the nature of their work.

An additional advantage is the ownership of Fokker 70 aircraft. These are very similar to their Fokker 100’s, but have a shorter fuselage and are more economical to fly. This means they can be used to transport a lower amount of people, at a lower cost, but using a plane which doesn’t need a lot of different spare parts or training. Most competitors have to use their Fokker 100 aircraft below capacity or a different aircraft at all, which decreases synergies and increases complexity. Skywest Aviation has a number of planes made by ATR because of this. An additional benefit of the Fokker 70 is its long range (coast-to-coast in Australia), something many of the smaller aircraft are unable to do.
The rarity of these Fokker 70 will make it very hard for any competitor to replicate this strategy in the medium to short run. Alliance owns close to 20% of all the Fokker 70 aircraft ever made.
The introduction of the Fokker 70 has initiated a slow winding down of their Fokker 50 aircraft, which share less commonalities with a fokker 100. The Fokker 50 is a turboprop aircraft as opposed to the other 2 which are turbine aicraft.

Management:
All directors of the company were founders, and have a sizeable amount of insider ownership. Together the founders still own around 40 million shares, out of a little less than 107 Million shares outstanding. This is above 35%, or a sizeable enough amount to represent the shareholder's interests. Since the IPO, only one of the founders has sold shares, and most of them have added shares in either on market purchases or by means of the Dividend Reinvestment Plan.

About half of the director's on the board have a long history in the aviation sector, with many of them having senior roles in safety and/or government agencies related to aviation. These guys are very respected in the Australian and New-Zealand aviation sector.

The managing director and until very recently the CEO, Shott McMillan, has bought 500,000 shares after December 2014, for a total sum of around 250,000 Australian dollars or about half a year’s wage in response to the dramatic fall following the changed earnings guidance for FY 2015 (more on that later).
In July another director who only owned around 35,000 shares purchased a further 110,000 shares on the market. This director had been with the company for a long time (before the IPO), and this is the first time he increased his holdings in the company by a “large” amount.

Earnings miss:
Alliance’s business was quite stable in the past due to the predictable and recurrent nature of the operations. The mining boom turning to bust has put this model under some pressure. In the last 2 years, Alliance had to do 2 earnings revisions, which have dampened the confidence in the company by the market. The FY 2014 results were below expectations because management did not “right-size” the fleet. This was done deliberately since they had won 2 big contracts, which would add about 25% extra revenue in FY 2015. The company had to train more employees and acquire additional aircraft in anticipation of the startup of these contracts.
In FY2015, the price of Iron Ore started to nosedive in sync with the price of oil and gas, prompting many operators to reschedule their staff so they could do with less FIFO flights. The result was a lower utilization than anticipated in FY 2015, and an impaired profitability. This series of events made them miss 2 profit guidances in a short order for which was otherwise a pretty predictable company.
Management has rectified this by right-sizing the company, starting the second half of FY2015, and the company should be able to post improving results going forward. One move was reducing headcount by 16%, and it appears this number will go down even more. They sold 2 aircraft to improve utilization while reducing debt outstanding and outsourced the heavy maintenance of their fleet (which they claim would provide a significant cost saving).
The fact that they are more efficient than most competitors should enable them to pick up some work from competitors, and management has hinted at this a number of times in recent announcements. These recent announcements have also been pretty upbeat, forecasting improved profitability together with the prospect of accelerated debt repayments in the following years.

Other Notable Shareholders:
In the beginning of 2015, Lanyon Australian Value fund bought a little over 5.7% in the company. This is a pretty secretive value fund, which has averaged 17% per annum since inception in July 2010 compared to the 11% of the ASX300. One of the 2 managers, Erik Metanomski, had been the founder of a previous fund which had done about 25% per annum before fees.
In recent interviews, he mentioned that the Australian mining services space would be a value trap due to continued pressure on margins going forward. Despite this view, he did see the value in Alliance to become a significant shareholder.

Conclusion:
Alliance offers an opportunity to own an efficient and effective company with an essential service in a down market led by competent and aligned management. While the earnings power can be somewhat volatile in the short run, the efficient way with which management runs their operation should produce a nice return on investment. The solid asset backing gives an investor in the company more safety because these maintain their value quite well and can be sold off to lower debt and better align the company to the operating environment in which it operates. The short to medium term goal to reduce debt should remove more uncertainty and make the big discount of the assets more obvious

Catalyst

- Improved operating metrics due to the right sizing of the business
- Reducing debt in the medium term
- Reinstating the dividend