2023-08-18 07:21:48 ET
Summary
- Wall Street analysts have a buy rating on Cargojet stock with a consensus price target of $144.33, representing a 42.8% upside.
- Cargojet's business model is different from legacy carriers, allowing it to maintain revenue despite declines in the air freight logistics industry.
- While the stock has potential upside, the current sentiment on e-commerce and airlines makes it less appealing for investment in the near term.
Wall Street analysts have a buy rating on Cargojet (CGJTF) (CJT:CA) stock with a consensus price target of $144.33 representing a 42.8% upside. While our financial analytics tool also shows an upside, I have labeled the stock a Hold as its risk-reward profile did not quite show appeal. Since then, the stock has lost 9% compared to a 5% gain for the broader markets. In this report, I revisit the price target for Cargojet and its latest results .
The Macro Reality For e-commerce
The current macroeconomic state is a complex one. During the pandemic, governments kept companies afloat, and that prevented many businesses from having to close down and employees basically kept their paychecks. With no holidays or social activities to spend the money on, e-commerce took a flight and that benefited the freighter airlines as passenger cargo capacity was running minimal due to the global passenger fleet being almost completely grounded.
Those times are now over; businesses and consumers are feeling the pains of high energy prices due to the war in Ukraine, and in some way, the current high inflation likely had to happen at some point because the pumping of money into the system as we saw during the pandemic comes at a price. During the pandemic, many jobs were secured by government loans or handouts and disposable income was high. E-commerce rode that wave where demand was high, but the ability to supply was not and prices of products increased. The result is that many products became very expensive and, now that we are hit with a day-to-day living being more expensive, those expensive products that consumers would have no problem paying for years ago are all of a sudden very expensive. Even with inflation tapering, that affects companies like Cargojet, which plays an important role in the express delivery chain in Canada. Perhaps inflation is becoming the lesser of problems now, but we still see that spending is more skewed towards travel and entertainment rather than e-commerce.
Cargojet: A Prudent Business Model
While the current state of e-commerce hardly is a positive one for freight airlines such as Cargojet, the company's stock price does seem to be partially pushed down by the sentiment regarding anything related to logistics. The reality is that the business Cargojet has is vastly different from the cargo operations that legacy carriers have. Depending on the geographical region, we see cargo revenues being down up to 50% as demand for air freight logistics is somewhat softer and the ability to supply capacity has vastly improved.
It's important to realize that Cargojet is not seeing similar declines due to the way its revenue is structured. The company has minimum volume guarantees as it operates for DHL ( DHLGY ) and Amazon ( AMZN ) with fuel costs being passed through to the customer. So declines in the cargo revenues as seen by the legacy carriers are not the type of declines we see at Cargojet.
Furthermore, since the free cash flow is the operational cash flow minus the CapEx, the way to optimize free cash flow is by simply optimizing the operating business which Cargojet is doing and reduce CapEx.
So, right now it is all about cost control, and the CEO has understood this. The company initially planned on expanding its fleet with 8 Boeing 777 airplanes. Four are destined to operate for DHL and that plan still stands, but the other four that were destined to support growth have been deferred. One airplane that would serve as feedstock for conversion was never bought, and the other three have been put up for sale. In February 2023, a tentative agreement was reached to sell two airplanes and a third tentative agreement is pending, meaning that the company successfully sold off its excess feedstock and with airplane shortages for passenger operations that can happen at relatively favorable terms. Overall, this reduces the net CapEx to around $200 million CAD, down from $350 million CAD previously estimated. Were it not for hail damage to affect two Boeing 777s, the sale would have closed in the second quarter and improved Cargojet's leverage.
Furthermore, the company is looking for opportunities for 4 to 5 surplus Boeing 757 airplanes in the ACMI or dry leasing space and works with partners to optimize block hour efficiency as flying the same volumes with less block hours significantly reduces costs since many cost elements are driven by block hour output. Apart from that, the company aims to reduce overtime and temporary workforce to save dollars while leveraging crews being trained for the Boeing 757 and Boeing 767 allowing equipment swaps where it makes sense from a cost perspective.
Cargojet Sees Expected Softness In Domestic Business
Cargojet revenues declined by 15%, but that also includes lower revenues from pass-through costs such as fuel. Since fuel prices dropped, the associated pass-through revenue is also lower, which is not a bad thing. If we look at the flight operations, we observed that revenues declined 3% mainly driven by lower domestic revenues as the flying is brought in line with demand for e-commerce logistics and B2B sales partially offset by indexing of rates. Total block hours for the entire operation were down around 6% with domestic revenues down 8.5%, so we can conclude that the decline in revenues is mostly caused by lower demand in the domestic revenue segment partially offset in ACMI revenues. Ex-fuel costs rose by $4.4 million which was mostly driven by higher depreciation costs due to a larger in-service fleet, partially offset by lower ground handling, crew, airport, and navigation costs. The decline in crew costs was primarily driven by lower external training costs. Overall, we do see that the company is controlling costs, but that is not helping the company really maintain margins. It is better than nothing, but the big cost-cutting is realized via CapEx cuts, which basically means the company is reducing its growth prospects for the near term since there simply is no point in investing while demand is soft.
Is Cargojet Stock A Buy, Hold Or Sell?
Wall Street analysts see a 43% upside for Cargojet share prices and while I see some challenges ahead, I can somewhat see why that is the case. I have entered the numbers into my stock valuation model and based on that model, we see a 47% upside when valuing Cargojet according to its elevated EV/EBITDA multiples. In an ideal investing environment without emotions, I would mark the stock a buy based on its median EV/EBITDA. However, I believe that the market is being extremely cautious towards airlines and particularly freighter airlines at this point, which will keep the performance of the stock under pressure. Valuing Cargojet in line with its peers, we would see less than four percent upside for this year, which is not appealing to me for investment. And 2024, while holding more upside for the stock, is a long time away from now in a market as dynamic as the air freight logistics market.
Conclusion: Cargojet Stock Could Offer Value
I don't think Cargojet is a screaming buy at the moment, but that is mostly because mixing sentiment into the pricing will not benefit Cargojet's stock price and right now we see that there is some stock price pressure on airlines as airfares are softening and, more importantly, for Cargojet, legacy carriers are seeing up to 50% decline in cargo revenues. The declines are not as steep for Cargojet, far from that in fact, but it does affect the sentiment on full freight investments. From a fundamental perspective, the stock is undervalued against its median EV-EBITDA but offers little to no appealing upside against a peer valuation. Combining that with the current sentiment on e-commerce and airlines, I don't quite like Cargojet for investment, even though I do recognize in the long term there could be sufficient growth and management is currently navigating the company for a deflated growth trajectory.
Long term, e-commerce should continue to benefit the Cargojet Inc. business, but in the near term there are some bumps, and the company is prudently altering its capacity plans for that. So, you could even consider buying Cargojet Inc. because the upside compared to projections is there, but it is the risk element I am not fully comfortable with. So, I am sticking with a Hold rating for at least another quarter.
For further details see:
Cargojet: Air Freight Stock With Risky Upside