ACHR - Archer Aviation: The Best Risk/Reward In The eVTOL Industry

2023-07-21 14:32:55 ET

Summary

• Archer Aviation Inc., an eVTOL manufacturer, plans to achieve FAA approval for its 'Midnight' aircraft by late 2024, with operations starting in 2025.
• The company's main partner is Stellantis N.V., which will provide manufacturing technology and a $150 million equity capital line. United Airlines has placed a tentative order for 200 of Archer's aircraft.
• Despite being in its pre-revenue development phase, Archer has over $500 million in current assets and a current ratio of 7.
• Archer is undervalued compared to its peers, despite being a first-mover alongside its rival Joby.

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Introduction

Archer Aviation Inc. (ACHR) is a company in the burgeoning eVTOL (electric vertical take-off and landing vehicle) industry that will provide aircraft for UAM (urban air mobility) networks. Archer will manufacture its 'Midnight' aircraft for sale to third-party operators (Archer Direct) as well as for its primary use in its own proprietary UAM 'air taxi' network (Archer UAM). Archer expects 'Midnight' to achieve operational regulatory approval from the FAA in late 2024, allowing the company to begin operations in 2025. It plans to scale to an ambitious production target of 2000 units annually utilizing the manufacturing capabilities of its partner Stellantis N.V. (the automotive giant formed by the merger of Fiat-Chrysler and Peugeot). I believe that Archer offers the best risk/reward ratio among eVTOL stocks because of the aforementioned Stellantis partnership, its two-pronged business approach that will leverage a proprietary air taxi network, and its cheap valuation relative to its competitors.

Industry Potential

People have talked about flying cars for decades. Henry Ford was quoted as saying in 1940, "Mark my word: a combination airplane and motorcar is coming. You may smile, but it will come." In 1935, the Autogiro Company of America constructed the prototype AC-35, an aircraft designed to be able to fold its wings and drive on conventional automobile roads. Despite its successful test, it never entered production. Flying cars have since been a human innovation always 20, 30, 50 years away - the poster child of the future that never arrives. However, in the last 20 odd years the development of a new class of aircraft called eVTOLs intends to make cars in the sky a reality. Visually, they look like hybrids between small airplanes and rotor-bearing helicopters. While not able to traverse conventional roadways like the long-imagined flying car, they will instead transport passengers through the sky, avoiding traffic altogether. These electric air taxis of the future will act as a middle ground between gasoline-hungry cars and planes, decongesting roadways and reducing travel times.

A 2022 industry report by Deloitte stipulates that eVTOL ride-hailing services could be prominent in major cities sometime within the 2030s. Morgan Stanley's prediction the value of the urban air mobility ((UAM)) total addressable market ((TAM)) in the year 2040 to be around the $1 trillion mark. By 2050, they expect this number to expand to $9 trillion. Granted, this report was initially published before the effects of the COVID-19 pandemic delayed production, but it shows that there is Wall Street confidence backing up this industry's aspirations. Advanced air mobility ((AAM)) craft will initially be piloted air taxis within major cities, both for passenger 'air taxi' services (think Uber) and cargo transport. However, as the initial success of eVTOLs is gauged, cargo transport AAMs will begin to be automated. Morgan Stanley's optimistic projections rely on the belief that this future automation, much like Tesla's proposed autonomous taxi network, will be able to rapidly scale beyond the major cities and will become commonplace around the world.

Decongestion of roadways will increase productivity and will allow people to get places easier, with the report even mentioning how hubs like Las Vegas currently suffer from direct transport routes from cities like LA, with eVTOLs providing another option while simultaneously easing up pressure on existing highway networks. This new class of transport is also being touted as a part of an electrified future as companies and governments alike push for the integration of zero-emission vehicles into the world's logistics network.

It's hard to predict the potential future for an industry that doesn't functionally exist yet, and only time will tell if Morgan Stanley's optimism is warranted. Nonetheless it will be exciting to see how the next decade unfolds for eVTOLs.

Key Partners

Archer's main partner is Stellantis N.V., the automotive manufacturing giant formed by the merger of Fiat-Chrysler and Peugeot. Stellantis is not only a significant equity investor in Archer, but will also be the exclusive contract manufacturer for Archer's Midnight eVTOL. The two companies recently began construction for a Covington, Georgia manufacturing plant that is expected to come online in 2024. The plant will initially be able to produce 650 craft/year, with future expansions able to potentially accommodate up to 2,300 units/year. Archer will be able to utilize Stellantis' manufacturing technology and expertise to rapidly scale to achieve its ambitious production target of 2000 units/year towards the end of the decade. In addition, Stellantis has offered a $150 million equity capital line available to Archer when they need it, assuming they hit certain development/production targets.

Another major partner for Archer is United Airlines, which placed a tentative order for 200 aircraft ($5 million/unit), with the option to order an additional 100 aircraft at the same unit price. United intends to use Midnight eVTOLs for transport to and from airports to provide United customers a way to skip the traditional traffic involved with making it to their flight on time.

Technology

Archer's production eVTOL model ( Midnight ) will have a maximum range of about 100 miles, but will focus on flights within a 20-50 mile range. Archer's aircraft, similar to the rest of the UAM industry, will focus on heavily-populated urban centers where ground-based traffic congestion is highest.

Midnight has six independent battery packs, each powering a separate pair of rotor blades. The frame is designed out of lightweight carbon fiber, and the vehicle itself is capable of a 1000 pound carrying capacity suitable for four passengers and a pilot.

Archer was the second eVTOL company to receive airworthiness criteria from the FAA, which will be used as the basis for Midnight's certification needed before it begins operations. The company is currently in the process of preparing for full FAA certification late-2024, using Midnight prototypes for test flights.

Financials

Archer is in its pre-revenue development phase, so evaluating the company's financial health through traditional means is meritless. Because of this, I believe that the best way to evaluate the financial health of eVTOL startups such as Archer is by looking at the assets the company has available. The next year and a half will be capital-intensive and will not generate any revenues, so the ability for the company to fund its operations until it can begin its operations is paramount. The company's current ratio stands at 7.28, which signifies that it has ample means of covering its short-term obligations. According to its most recent 10Q filing, the company has over $300 million in cash on hand (provided by its SPAC reverse merger in 2021). Coupled with its $150 million equity capital line provided by its partner Stellantis, I believe that the company has the capital needed to make it through the pre-operational phase. According to Archer's most recent 10-Q filed in May, the company realized a loss of $113.1 million for the three months ending March 31, an increase from the $59.2 million loss in the same time period last year. The main driver was a 139% increase in research & development costs, from $27.5 million to $65.8 million, in the quarter, which is to be expected as the company ramps up R&D spending preceding FAA certification and manufacturing commencement. Last year's 10-K filed in March shows an annualized loss from operations of $347.4 million, though excluding stock-based compensation of $102.8 million brings this operating loss to $244.4 million. Predicting R&D costs can be difficult, but assuming the R&D portion of this figure ($145.4 million excluding stock compensation) doubles, the total operating loss for 2023 could be around $400 million, including general and admin costs. With current assets of $545.5 million at the end of FY 22, the company should be able to comfortably cover this year's cash burn. Next year could prove to be tighter, however, and it appears likely that Archer will have to exercise its $150 million equity line from Stellantis. The stock will likely go through further dilution next year, in addition to debt financing (which may become difficult depending on the macroeconomic backdrop). I believe that the company will be able to cover expenses in 2024, though if the FAA certification process is significantly delayed, the company's financial future beyond next year becomes less clear. This one of the risks I outline in the headwinds section.

Now as for projecting future revenues, Archer has said it plans to charge between $3-4 per passenger per mile. For its proposed route between Vertiport Chicago and O'Hare International Airport (about 12 miles), this could mean ticket prices in the $35-$50 range. Third-party projections put the estimated ticket costs for a routine 25-mile flight in the ballpark of $110/seat. The company believes it can eventually provide 25 trips per aircraft per day, which (with four customers per flight) could mean anywhere between $3,500-$11,000 in revenue per aircraft per day, using the posited ticket price estimates above. Now, this is certainly an optimistic estimate, especially considering that consumer demand for such a service may not pan out as hoped. At this stage, it is also hard to predict how quickly Archer will able to scale its UAM fleet, though, assuming its projected 2024 FAA approval, the company believes it can produce 250 aircraft in 2025, 500 in 2026, and 650 in 2027, with plans to scale to an ambitious production target of 2,000 units annually utilizing the manufacturing capabilities of its partner Stellantis.

Many factors will have an effect upon Archer's future revenues. I created a table demonstrating how four different scenarios over the next ten or so years could play out. The table shows how factors like fleet size and passengers per flight can impact the UAM service's sales. The numbers I use are conservative relative to Archer's investor presentation projections, which I believe are too optimistic to base a thesis upon. I took the company's projected 25 trips-per-craft-per-day and lowered it to 10-15, as I believe demand will not be as strong as the company projects for the first decade of operation. Further, fleet size will be highly dependent on Archer's ability to scale its production. The company projects it can produce 2,000 craft annually around the beginning of the 2030s, another number that may be overly optimistic. However, even if the company only has capacity for 1,000 units annually by 2030 and only ramps up to 2,000 around 2035, it should easily be able to assemble a fleet size somewhere within one of the cases I've outlined below, assuming around half of its units go to its UAM network and the other half towards its Direct segment.

Source: Author's Calculations

I believe the Mid Case offers a realistic projection for Archer's UAM segment in the mid 2030s, based simply on the fact that consumer trust in this new technology will take time to develop, which will hinder demand for the service for the first few years of operation. If consumers are ready to adopt out the door, the Best Case may be a better proxy for revenue projections in the given time frame.

As for projecting revenues for Archer Direct around 2035, we will use United's order as a baseline, which puts the sale price of each Midnight craft at $5 million. Assuming the company can scale to its proposed capacity of up to 2,000 craft annually by 2035, projecting revenue for this segment again becomes a game of predicting demand. I chose these unit numbers by assuming that around half of a theoretical production number between 1,000 and 4,000 by the year 2035 goes towards its UAM fleet, and the other half to its Direct operation.

Source: Author's Calculations

Valuation

Without revenue or near-term revenue estimates, traditional valuation metrics like the EV/EBITDA or PEG ratios will not be helpful in evaluating companies involved in the early days of the eVTOL industry. The closest metric we can use to compare the valuation of ACHR vs the other stocks in its industry is the price/book ratio.

As we can see, ACHR has the lowest P/B valuation among its public competitors, despite being one of the two companies in the space that are closest to FAA approval and operational commencement (along with Joby Aviation (JOBY) ). I find this confusing though, as the market is pricing the stock on a similar level with German startup Lilium (LILM), who's unique Lilium Jet eVTOL design only recently received its G-1 certification basis from the FAA , which Archer achieved back in 2021 . I believe that Lilium would need a type-conforming prototype (similar to Archer's Maker it unveiled in 2021 ), which it plans on completing by the end of the year , as well as proposed certification criteria from the FAA, which Joby and Archer received last year, to have a similar valuation to Archer.

Archer and Joby are further along in the development process compared to Lilium and Vertical Aerospace (EVTL), whose valuations are more speculative at this current point. As demonstrated in the previous table, Joby is valued around double Archer's P/B. Joby is in an arguably better financial better position than Archer, with a current ratio of 33.42 and almost a billion dollars of cash on hand, which I believe does warrant a premium relative to ACHR. However, I believe that the market is unfairly discounting Archer's potential relative to Joby, which has a market cap about 5x as high despite being only a few months ahead of Archer on the certification path. No doubt, Joby may be safer financially and closer to operations, but any concerns about ACHR's ability to cover its expenses over the next two years are unfairly weighing down upon the stock price and have put the stock at a better risk/return ratio compared to Joby, whose 2x P/B, 5x market cap valuation buys a similar-stage company with many of the same risks. Archer is a higher risk play from a financials standpoint, but if FAA approval timelines go as projected, there will be no other reason for the major discount it trades at compared to its closest peer Joby.

Industry Headwinds

With every burgeoning industry, there will always be initial roadblocks that must be overcome. In the eVTOL industry, the three main obstacles are regulation, consumer emotion, and infrastructure.

Headwind 1: Regulation

Morgan Stanley's industry report mentions how it will ultimately be regulation, not technological limitations like battery life, that will be a major limiting factor for eVTOLs. This is exemplified by the FAA, which only recently released its proposed airworthiness criteria for Joby Aviation's JAS4-1 eVTOL, 4 years after the company initially sought regulatory approval for its craft. The agency's proposed certification requirements include standards used in traditional aircraft, but they also outline new standards specifically designed around the intricacies of Joby's rotoblade eVTOL. For example, Joby's craft will be quieter than traditional helicopters, giving birds less advance warning and increasing the chances of bird impacts. Traditional fixed-wing airplanes can glide to safety in the event of in-flight catastrophe, a luxury that drone-like eVTOLs like Joby's will not possess. For an in-depth explanation of the FAA's proposed certification criteria, you can view its submission to the Federal Register , but needless to say, ironing out a comprehensive and cohesive set of regulations for eVTOLs will take time. In fact, the FAA itself will have to adapt to an age of fast-paced innovation, as House Aviation Subcommittee Chair Garret Graves said , "In the next 10 years, the aerospace industry will involve an ever-increasing number of drones, the introduction of eVTOLs, the reintroduction of civil supersonic aircraft, and the expanded use of commercial space transportation vehicles," he said, adding: "Our regulatory organizational structure must adapt if we're going to safely integrate new entrants into the market."

Headwind 2: Consumer Emotion

In 2019, Deloitte Consulting conducted a study of 10,000 participants in which people were asked about their thoughts on future AAMs (advanced air mobility craft, includes eVTOLs). Around 8 in 10 respondents stated at least major concern that these aircraft would be unsafe. No doubt international regulatory bodies and eVTOL manufactures will do everything in their power to ensure the safety of these next-gen aircraft, but getting the word out on the street, even after regulatory issues are sorted out, will take time.

Headwind 3: Infrastructure

UAM eVTOLs will need somewhere to land , and cities may need to spend billions to build the necessary infrastructure needed to accommodate everything from aircraft storage to emergency landings. Some companies like Volatus are attempting to bring down the cost of proposed 'vertiports', but these startups are still in early development. Building new infrastructure will take considerable effort and may act as a potential headwind to the scalability of the eVTOL industry.

Archer-Specific Risks

Risk 1: FAA Certification Delay

As mentioned above, Archer may see rough straits if FAA certification is delayed into 2025. This is probably the biggest risk factor in Archer and could see significant dilution and leveraging depending on the length of delay.

Risk 2: Stellantis Partnership Evaporates

This headwind is highly unlikely, as Stellantis wishes to become a leader within the eVTOL manufacturing space and has put considerable investment of manufacturing and financial resources into Archer. However, in the event that Stellantis decided to backpedal or faced significant financial challenges and terminated its partnership, Archer would need to develop its own manufacturing and distribution network and could cripple its operations. This risk is much less likely to come to fruition compared to Risk 1, but nonetheless should be considered when building a thesis around Archer.

Why is Archer Different?

The eVTOL space is in its early stages, which means that every stock within should be looked at as a high-risk play. If FAA certification is delayed, this entire thesis could fall apart. With this consideration, however, I believe Archer Aviation offers the best risk/reward ratio in the industry. With the lowest price/book among its peers, the company has the lowest premium relative to its intrinsic value, despite being one of the two first-movers in the industry along with Joby (which is valued at a P/B of over 2x Archer's). This first-mover advantage cannot be underestimated, and will be important in gaining a strong competitive advantage early on in the operational stage.

Further, Archer, unlike its most developed rival in Joby, will operate a two-pronged business model (Archer AUM and Archer Direct), which will expose the company to the benefits of both selling excess craft to third parties while building brand recognition and a loyal customer base through its in-house AUM 'air taxi' service. Another reason I believe Archer is poised to be an industry leader is its partner in Stellantis, which will provide the manufacturing and financial capital needed for Archer's ambitious expansion plans. This will be an advantage compared to others in the space that're developing their manufacturing footprint from the ground up and, perhaps more importantly, will give Archer the backing it needs to market and distribute the flying cars of the future.

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