The ACCC has delayed its decision on the QAN proposed takeover of Alliance Aviation (AQZ) until 20 April. QAN currently owns 19.99% of AQZ but has no Board representation. AQZ has massively upscaled its fleet which will most likely be wet leased to QAN.
The proposal dates back to May 2022 when QAN said it would pay $4.75 per share for the rest of AQZ. QAN would issue new shares valued at approximately $614m with the transaction expected to be EPS accretive for QAN, before synergies. At the time, the $4.75 offer was a 32% premium to AQZ’s share price which is almost the same premium today (AQZ $3.51). AQZ’s current market capitalisation is $564m and it has net debt of $231m as at 31 December 2022 giving it an enterprise value of $795m.
AQZ is guiding the market to expect a profit before tax of $50-55m in FY23f and is ‘comfortable’ with consensus forecasts of $77m in FY24f.
AQZ’s flight hours have increased substantially mainly due to the increase in wet lease hours flown which now represent more than half of AQZ’s capacity. Revenue has also increased although it currently represents just 26% of group revenue in 1H23. But it is clear that the wet lease category will dominate AQZ’s earnings in the near future as the E190 fleet ramps up.
The most recent announcement from AQZ this week outlined the additional purchase of 30 E190 aircraft over a period of two years. Once all these aircraft are acquired, AQZ will have a fleet of over 100 aircraft (currently 76) comprised of 37 Fokker 100/70 turboprops and 63 Embraer E190 jets.
The QantasLink fleet consists of 18x F100, 50x Dash8 and 20x B717 aircraft. There will be considerable work being done in the QAN scheduling department that will incorporate the wet leased fleet from AQZ into its planning.
The ACCC has taken an eternity to sort through the baggage of this takeover proposal. The main concern is likely to be the potential for QAN to exert undue influence on regional flight routes and have anti-competitive outcomes. Unfortunately, it appears that QAN is already exerting considerable influence over AQZ even without Board representation or full ownership.
At the time of the proposal, QAN was already the largest client of AQZ which has since added 18 new E190 aircraft, built a $60m aircraft maintenance centre at Rockhampton (half funded by all three levels of Government) and now committed to a further 30 E190 aircraft purchases over the next two years.
The latter is going be wet leased to QAN making AQZ a virtual subsidiary of QAN, regardless of what the ACCC decides.
The E190 aircraft is ideally suited to flying long domestic routes across Australia. A twin-engine jet aircraft, it is only slightly smaller than a B737-800 and can carry 114 passengers on distances of up to 4.500km. This is ideal for FIFO businesses based in the Pilbara, Kalgoorlie, the coal-mining towns in Queensland and BHP’s Olympic Dam in SA among many others. We note that AQZ’s network has no contract presence in NSW or Victoria. Instead, the company has bases in Brisbane, Adelaide and Perth with additional operations in Cairns, Townsville, Rockhampton and Darwin.
QAN has obviously not waited for the ACCC’s decision and has instead got on with ‘encouraging’ AQZ to rapidly expand its wet lease fleet.
In October 2022, the ACCC denied an extension to AQZ’s 5-year agreement with Virgin Australia on their co-ordination of FIFO flights.
Given the inexact timing of delivery of each of the additional E190s into AQZ’s fleet, the company has not been able to provide a value on the transaction.
The guidance given by AQZ at its interim result in February was clearly before the announcement to increase the E190 fleet. The additional aircraft may have little to no influence on the FY23f result but will incrementally change the outlook for FY24f. It is also not clear whether QAN will adjust its offer to AQZ shareholders based on the enlarged fleet.
AQZ’s earnings are relatively small in comparison to QAN but it is the flexibility added to QAN’s regional fleet and network that really counts. This may happen whether QAN owns 19.99% of AQZ or 100%.
Investment View
QAN’s earnings are on a strong positive trajectory driven by increasing yields (higher airfares), reduced operating costs and hence higher margins. The controlled release of its previously shuttered capacity due to COVID-19 will extend the earnings gain.
Earnings revisions following the 1H23 result were not large but already incorporated the very big jump in pretax profit as domestic and international travel recovers.
QAN extended its share buyback program by $500m at the interim result (total $900m). While no interim dividend was declared, it is possible a final dividend might accompany the FY23f result in August.
QAN has a large fleet replacement program underway and with the balance sheet below optimal leverage, it is comfortably placed to cope with the expenditure.
Risks to Investment View
Global air traffic recovery may be affected by the potential for recession in various regions and the slow return of China to world markets. The Russia/Ukraine conflict is restricting global air traffic routes and may continue to do so. High fuel prices may persist, and this could affect profitability of airlines.
Recommendation
We have retained our Buy recommendation.
