AeroCentury Corp.: The real friendly skies
The airline business is a confounding business; profits are often as ephemeral as the contrails from a Boeing (NYSE: BA) 737 — a year in the black can easily be vaporized by a subsequent year in the red. Then again, profits are often transitory when business economics couple high-fixed costs (airplanes and legacy liabilities) with high-variable costs (employees and fuel).
That's not to say money can't be made moving people through flight; it can if you either run a more efficient traditional transportation operation, like Southwest Airlines Co. (NYSE: LUV), or eschew tradition all together, and focus on the airlines themselves, like AeroCentury Corp. (AMEX: ACY) of Burlingame, Calif.
AeroCentury leases used regional aircraft and engines — purchase prices of $1 million to $10 million — to various airlines around the globe. At Sept. 30, 2007, the company owned eight deHavilland DHC-8-300s, three deHavilland DHC-8-100s, three deHavilland DHC-6s, fourteen Fokker 50s, two Saab 340As, six Saab 340Bs, four Fokker 100s and one turboprop engine. Most of AeroCentury's business is conducted overseas: Europe and the United Kingdom accounted for 39% of 2006 revenue, Asia for 25% and the Caribbean for 21%. The remainder is spread equally among the United States, Canada, Africa and South America.
Lease terms on AeroCentury's aircraft panoply are typically five years or less. To improve the marketability of an aircraft after the lease expires, AeroCentury includes lease provisions that provide for maintenance and return conditions. These provisions ensure the company receives its property back in salable or lease condition, or it receives sufficient recompense from the lessee to cover any maintenance or overhaul required to make it so.
The most intriguing aspect of this leasing-and-maintenance business model is that it doesn't require employees to execute. AeroCentury's aircraft are managed and administered under an agreement with JetFleet Management Corp., for which JetFleet receives a management fee based on the net asset value of the assets it manages. (AeroCentury paid JetFleet $2.75 million in management fees in 2006). The arrangement relieves AeroCentury of the burden, cost and aggravation of managing employees.
The wind has certainly been at AeroCentury's back through much of 2007. Revenues for the nine months ended Sept. 30, 2007 were $16.4 million, versus $13.8 million in the prior year, a 19% year-over-year advance. Net income was $2.5 million, or $1.58 a share, versus $200,000, or $0.10 a share, in 2006, an eleven-fold increase. Investors have been the principal beneficiaries of this prolonged tailwind. AeroCentury's stock has appreciated 400% over the past 12 months. The stock closed at $24.50 on Friday, with shares ranging between $7.01 and $26.67 over the last 52 weeks.
More important, this tailwind appears unlikely to subside any time soon. According to the Travel Industry Association of America, overall traveler spending by domestic and international visitors increased by 7% to $700 billion in 2006, versus $654 billion in 2005. The TIA is estimating that number should increase 5.7% to $740 billion in 2007 and by 5.2% to $778 billion in 2008.
More of these itinerants are expected to move about via regional carriers. Forecast International, a market research firm, projects an overall market for 3,800 regional aircraft, including 2,539 regional jets and 1,261 turboprops through the end of 2016, with growth driven by increased air traffic, rising fuel prices and competition.
Emerging macroeconomic events could also favor AeroCentury. Many of the company's credit facilities are variable-term, dependent on the lender's prime rate or LIBOR. In the United States and United Kingdom, short-term rates have moved lower — a trend that could continue into the relevant future if the U.S. economy weakens further. And if it does, no big deal. Regional carriers traditionally fare well during recessionary periods; they tend to be flexible, opportunistic and have more manageable cost structures than their transcontinental confrères.
As for the analysts, the one who follows AeroCentury likes what he sees. In late November, Taglich Brothers' Howard Halpern opined that AeroCentury is worthy of a “speculative buy” and increased his 12-month price target to $23.45 per share (which has since been surpassed) from $18.90. Halpern forecasts total revenue of $22.5 million and net income of $3.27 million, or $2.05 per diluted share, for 2007, followed by revenue of $24.9 million and net income of $3.7 million, or $2.25 per diluted share, for 2008 (subject to the impact of AUG AIR-1, a recent accounting change for airline maintenance contracts).
Investors have been flying high with AeroCentury, but that doesn't mean the stock is stratospheric; remarkably, it's still flying below industry benchmarks. AeroCentury shares carry a price-to-earnings ratio of 13, a significant discount compared with an average of 19.79 for the Aerospace & Defense industry, and a price-to-book ratio of 2, versus the industry average of 5.21. Moreover, AeroCentury's recent sales and earnings growth have both outpaced the industry averages.
But one caveat, lest anyone is a quick-hit artist: AeroCentury isn't a trader's stock. In the past three months, average daily volume has been 11,200, with bid/ask spreads ranging between a dime to a dollar. So if you climb aboard, consider AeroCentury (ACY) more of a big transcontinental investment instead of puddle-jumper investment, even though it more closely resembles the latter's stock and trade.
