logo for airline companyWhopper is a deep value investor. His site is http://www.whopperinvestments.com, and he can be reached at whopperinvestments @ gmail . com

Recently, I’ve been really interested in companies with a history of solid profitability trading for less than tangible book. Actually, now that I write that it sounds kind of ridiculous- what value investor wouldn’t be interested in profitable companies trading for less than book??? Haha, anyway, I’ve been focusing on the area more than normal. One company that fits that description is Air T (AIRT).

AIRT consists of three segments. The first (and largest) is operates overnight, small package delivery planes for Fedex. Given that virtually all of the revenues in this division come from Fedex, there is obviously customer concentration risk. However, AIRT owns 2 of the 7 “feeder” carriers that operate this business for Fedex, and the relationship dates back to 1980, so it’s doubtful that they would lose the business… obviously a cause for concern though. The other two businesses are aircraft ground sales, which mainly delivers de-icing equipment and historically has derived the built of their revenue from the Air Force, and aircraft ground support, which provides ground support for airlines.

At first glance, the company looks like an almost perfect value investment. They’ve grown rapidly and consistently over the past few years. ROIC and ROE have been excellent and the company grew right through the recession. The companies balance sheet is clean, with basically no net debt and about a quarter of  their market cap in cash, and at current prices they trade for about 12x earnings, around 6x EV / EBIT, and around a 8% discount to tangible book. Plus, the Fedex business is pretty stable and, because Fedex supplies the equipment for a nominal fee, generates great ROIC. So yes, there’s a lot to like here.

Unfortunately, there’s also some cause for concern. The ground support business for airlines earned the vast majority of its revenue from a contract with Delta which expired at the end of last year and was not renewed. This will likely take all or at least the vast majority of this segment profits away, which were accounting for about ~$1.2m in operating income per year. The ground sales business, which the company relied upon for the vast majority of their growth the past few years, derived the vast majority of its revenue from the air force, but the air force reduced orders to almost nothing so far this year which has cut this segments operating income from $3.5m in the first nine months of last year to just $750k in the first nine months this year. If the Air force orders remain low due to budget cuts or switching to a competitor, this segment’s profits may never return to their prior levels and the segment could be a huge drag on ROIC.

There does appear to be some hope though. The company notes the ground sales business won a $10.5m contract from the city of Charlotte, and orders from the air force are slowly resuming. If the air force does resume ordering at their prior rate, AIRT will resume their earnings growth and today’s price will prove much too low.

My take

I do think the company’s too cheap, but there are so many huge tail risks here that I just can’t invest in it. You’re exposed to customer concentration on two fronts (Fedex and Air Force) and a segment that accounted for 10% of revenue losing 70%+ of their revenue. There’s just so much that could go wrong here that I don’t think you have quite enough margin of safety. That said, management seems excellent, the company has a very solid history of profitability, and I don’t think there’s much capital allocation risk here. I like the company, but I’d personally prefer AEY at today’s prices.

Disclosure- Long AEY

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