Alliance Aviation reported a step change in FY23 earnings due to its significantly expanded fleet aligned to wet leases to Qantas. The ACCC rejected QAN’s takeover proposal in April 2023.
FY23 result. AQZ increased its total flight hours by 58% as it added multiple new aircraft to its fleet during the year. It now has 33 Embraer E190 aircraft to complement its legacy fleet of Fokker aircraft. The company specialises in flying contracted, charter and wet leases (plane plus crew) and a small amount of regular public transport flights. Consequently, revenue increased 40% to $517m while EBITDA jumped to $122m from $60m in FY22. AQZ reported a net profit of $36.5m in FY23 but did not pay a dividend.
Net debt including lease liabilities at 30 June 2023 was $241m. Net operating cash flow of $41m was down on last year as the company paid more interest and tax. Capex of $82m was partly funded through higher debt.
Outlook. FY23 was certainly a quantum change for AQZ in terms of its capacity which is now 96% FIFO and wet leases. The ACCC’s decision to reject QAN’s $4.22 per share offer to acquire the remaining 80% of AQZ that it does not own was a disappointment but not necessarily a setback. QAN had accumulated a 19.9% stake in AQZ in February 2019 before reaching an agreement with AQZ in May 2022 to acquire the remaining shares in the company.
The ACCC said the transaction would substantially lessen the supply of air services to resource companies in Queensland and WA. The ACCC had also rejected a re-authorisation of AQZ’s agreement to co-ordinate FIFO business with Virgin Australia arguing the public benefits had not been demonstrated in the six years the agreement had been operating.
Consequently, the FIFO market is theoretically a three-player market, but in reality, AQZ is now stridently aligned with QAN although AQZ is the clear beneficiary. We estimate AQZ has approximately 20% of the charter flight market in Australia and QAN has about 40% so the ACCC’s concern is well founded.
The substantial increase in the E190 fleet is largely wet leased to QAN so there is very little risk in the expansion. QAN will effectively be wet leasing 30 aircraft in AQZ’s total fleet of 70 aircraft and this will represent a higher proportion of seats given the larger capacity of the E190. AQZ can thrive without the full ownership by QAN.
The E190 is an ideal aircraft for the Australian regional market. With a capacity to fly 4,500 km at over 870km/hr, the E190 can carry around 114 passengers anywhere across the continent. AQZ has no contract presence in NSW or Victoria, but has bases in Brisbane, Adelaide, and Perth with additional operations in Cairns, Townsville, Rockhampton and Darwin.
The company selected Rockhampton for a major $60m maintenance hangar that will save approximately $5-7m pa in base maintenance costs. With government funding assistance, the actual cost to AQZ was $30m.
The fleet expansion is progressive with the 30 E190s being delivered across FY24 (16), FY25 (10) and FY26 (4). AQZ said up to 11 of these aircraft may be disassembled for parts. The other 10 aircraft will be used for wet lease commitments and the rest for future growth. AQZ has also acquired a further 4 E190s to plug a shortfall in FY24 capacity. All four aircraft will be in service by March 2024.
Investment View
AQZ has transformed into a fully fledged FIFO operator with significant capacity wet leased to QAN. It does seem that the QAN takeover is unlikely to be allowed by the regulator leaving QAN with 19.9% ownership but with substantial influence on AQZ’s future earnings. The situation remains beneficial to both parties, in our view.
With further capacity additions likely, we think AQZ’s earnings trajectory is solidly upwards, depending on the demand for FIFO capacity and the retention and expansion of contracts for this purpose.
With the takeover probably off the agenda, we think AQZ is now fairly valued at a PE ratio of 8.9x FY24 EPS. We reduce our recommendation from Buy to Hold.
Risks to Investment View
The growth in contracted and wet leased capacity might not be sustained if activity decreased. Operational performance might not be sustained at acceptable levels which could lead to contract cancellations. Competition in the airline industry is intense. Costs increases could affect profitability.
Recommendation
We have reduced our recommendation from Buy to Hold.
