EADSF - Air Transport Services Group: Upside Remains After A 45% Surge

2023-08-24 13:15:35 ET

Summary

• ATSG stock saw a 23% drop in May, the stock has subsequently gained 45% as expected.
• ATSG has reduced CapEx forecast for 2023, on lower demand for converted freighters.
• Current share prices still do offer some upside.

In May, I started covering Air Transport Services Group, Inc. ( ATSG ) stock after it nosedived 23%. Analyzing the results and the reason for the drop, I concluded that the sell-off was unjustified and attached a buy rating to the stock. Interestingly, the view on ATSG stock from Seeking Alpha analysts and SA Quant diverged with a Buy rating from SA Analysts and a Sell rating from the Quant. In this report, I revisit my rating for ATSG.

SA Analysts, Wall Street Or Quant, Who Was Right?

As I previously mentioned, I would not want to make a case either in favor of the Quant rating or Seeking Alpha analysts, as I believe both serve the reading audience in their own way. As an example, before ATSG stock tumbled the Quant rating had already changed the rating to sell while Seeking Alpha and Wall Street analysts had not done so. So, you could say the Quant rating system was right there. However, what we also see is that the system incorporates some sort of lag. From the graph it is visible that while the stock had a buy rating and strong buy rating for some time, the price itself did not move which likely triggered a Hold rating and the rating was changed to Sell after the stock price tanked in February. So, that is not the way you would want any Quant system to function and emphasizes the need for human coverage.

In a time where we have been growing fond of AI and algorithms, we should also look at what returns some rating systems would yield instead of blindly following them. What I found is that in the phase SA Quant had a buy rating, the stock performance was -9%, -25% in the time the rating was Hold and -2% when the rating was Sell. Those are not returns I would be happy with. In fact, the system failed to identify a buying opportunity.

Interestingly, I marked the buying opportunity and I put the upside on 45% based on forward estimates:

The forward EV/EBITDA is 4.2x while the company's median is 6.1x, which would put the price target at $22, providing 45% upside from current trading levels.

Interestingly, ATSG stock has now seen that 45% upside materialize, and I would say that if you invest there are lessons to be learned and the lesson here could be that while machines and algorithms greatly ease life, they are not fail or foolproof. At the same time, it is interesting to consider whether there is any additional upside or whether it is time to take profits.

Air Transport Services Group Sees Declines

Revenues increased by $19.7 million year-over-year, but that was fully offset by higher staffing and maintenance costs. The result was that operating income declined slightly while decline in pre-tax earnings was even higher due to higher interest costs and a swing in retiree benefit credits.

In the ACMI Services segment, pre-tax earnings were up $2 million or 10% due to better passenger airline operations and more Boeing 767 freighters in service. Cargo hours were up 1% offset by 2% lower block hours. Nevertheless, it was improvements in DoD flying revenues for aviation fuel that positively impacted performance.

The leasing business, CAM, saw revenues increase from $109.7 million to $115.3 million but earnings declined 22% to $31 million. The business leased five more Boeing 767-300s but had to absorb the return of 10 Boeing 767-200s over the past twelve months which does pressure revenues. On cost sight, the higher interest rate environment resulted in $5 million higher interest costs and $2 million higher depreciation driven by higher fleet counts for the Boeing 767-300 and Airbus A321 partially offset by a lower number of owned Boeing 767-200s.

ATSG: Increased EPS Guidance, Cuts Capital Expenditures

On an adjusted basis, the results for Q2 showed stability and that is actually nothing to get excited about. In May, the company had lowered its EPS forecast by $0.30, but the company has now increased that again by $0.10 to $1.65-$1.80 due to improved ACMI service performance and the placement plan for leased freighters. The company is also reducing the CapEx outlook by $65 million to $785 million reflecting a somewhat softer market for freighters, which reduces the need for feedstock airplanes and engine overhauls.

If we process the projections for this year and the next years, we actually see that ATSG stock has remaining upside. Using the median EV/EBITDA for ATSG rather than the higher transportation, we get to 19% upside for 2023 with another 5% for 2024 and 2% for 2025. As a result, I continue to mark ATSG stock a buy with a price target of $26. That is slightly lower than the $26.43 average price target from Wall Street analysts.

Conclusion: Upside Remains For ATSG Despite Cargo Softness

Air Transport Services Group, Inc. did increase its guidance after the market shocking downward revision in May. As noted in my previous report on ATSG, the cargo business remains strong, in the sense that placed or chartered freighters are not made redundant. There is, however, some softness and that alters the CapEx profile as the growth trajectory for acquiring airplanes for cargo operations is tapering. The passenger ACMI performance has improved and that combined with the expected freighter lease placements has resulted in a small upward revision of the EPS guidance which could also indicate some expected share repurchases in the remainder of the quarter as CapEx has been reduced.

From the current price levels, I believe that ATSG still offers some upside. It's a buy with the performance for 2023 in mind, but after that unless the macroeconomic environment improves, there are not a lot of upsides for the stock that would make it attractive for a longer-term investment.

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