2023-06-20 19:15:49 ET
Summary
- Harbor Diversified on a net cash basis has further upside.
- The company is transitioning from United Airlines operations to American Airlines, but provides no guidance on any revenue impact, while this should be predictable at this stage.
- While upside remains, the risks make the stock less appealing than should be the case.
I've been analyzing regional airlines for a while. Recently, I commenced coverage of Air Wisconsin (Harbor Diversified) (HRBR) and that is an airline whose stock name does not directly suggest it is in any way affiliated with anything related to airlines. In this report, I will discuss the company’s most recent earnings.
What Does Harbor Diversified Do?
The name does not directly make it clear, but Harbor Diversified is in essence Air Wisconsin. The company was originally formed in November 1992 as Initial Acquisition and merged with Hollis-Eden becoming Hollis-Eden Pharmaceuticals in 1997. In February 2010, Hollis-Eden Pharmaceuticals was merged with its wholly-owned subsidiary and renamed Harbor BioSciences and in January 2012, the company acquired 80% of the issued and outstanding capital stock of AWAC from Amun LLC ("Amun"). In February 2012, Harbor BioSciences was merged with its wholly-owned subsidiary and renamed Harbor Diversified. In January 2016, said company acquired the remaining 20% of the issued and outstanding capital stock of AWAC from Amun. Air Wisconsin basically acquired Harbor Diversified, a pharmaceutical company, for its tax assets and didn't file for years until a shareholder sued the company and won. It's quite the story on how the airline was flying under the radar even for its shareholders and even now if you look for an investor website, you won't find one. Just for that reason alone, I will not be regarding this a buy as I find transparency with management to be of importance and not being able to reach out to management or investor relations in a clear way is reason for concern.
A Look At The First Quarter Results
First quarter revenues declined by 12%, driven on 19% lower block hours execution. The drop in revenue, which was driven by pilot shortages and the wind down of operations for United Airlines (UAL), was less steep compared to the block hours drop due to recognition of deferred revenues from United, some revenue in flow from the new agreement with American Airlines ( AAL ) and slightly higher pass-through costs translated to the top line. Costs rose by $8.4 million, which was primarily driven by higher aircraft maintenance costs and higher wages, reflecting better employee pay. Overall, we saw decline on revenue level and an uptick in costs level, resulting in squeezed profits. Net income tumbled 90%, so we are definitely not looking at pretty results, and we are seeing how the regional airlines, which should be relatively well shielded against oil price and fare fluctuations, are squeezed by pilot shortages.
What Are The Risks For Air Wisconsin?
Obviously, continued attrition continues to play a role for all regional airlines and as long as mainline carriers continue to fish in the pilot pool of regional airlines, there will be a pressure on block hour production. In March 2023, Air Wisconsin commenced operations for American Airlines ((AAL)) while by June 2023, the final flights for United Airlines ((UAL)) will be halted. In a ramp up schedule by October, 40 airplanes will be utilized. As I pointed out previously, we are seeing no sign that the transition will keep the revenues stable, hence I do expect a reduction in revenues further amplified by the fact that under the CPA (Capacity Purchase Agreement) with American Airlines initially only 40 airplanes will be covered with options of another 20 to be added. The current United Airlines CPA covers 63 aircraft, so one would say there will be quite a mismatch initially through the ramp up if the options for the other 20 airplanes are not utilized the ability to produce block hours will be even more limited beyond the pilot shortage scope. Does that hurt Air Wisconsin tremendously? No. Effectively, there are only 36 airplanes in operations right now, driven by the pilot shortage, but it is the ramp up with a mismatch in United flight activity (ending June 2023) and American Airlines flight activity being fully ramped up by October 2023 for the 40 airplanes that makes me wonder how strong their revenues are going to be.
Furthermore, the stock itself also does embed some risk elements as it trades at a relatively low price and has a low market cap, which could cause significant undesired price fluctuations and investors should inform themselves of the possible volatility this can introduce to the company’s pricing.
Is Harbor Diversified Stock A Buy?
Regional airlines were considered the prime investments to ride the air travel recovery, but that sentiment faded once mainline carriers disrupted the regional carrier operations. We really have no insight on when operations will be recovered and what the growth trajectory for regionals is. Specific for Harbor Diversified, I note the lack of any strong trends or management comments that give any reassurance on what we can expect. To me, management transparency is important and going through the filings, management does not provide a lot of detail even though there are significant items that will affect operations this year that should be somewhat quantifiable at this stage.
Furthermore, the company has a negative enterprise value, making the typical EV/EBITDA valuations I apply unsuitable for this stock. It is also an indication that the company might not be using its cash efficiently. Currently, the company has $2.42 in net cash and equivalents per share which means that solely valuing the net cash position provides another 8% upside after the 10% stock received since I started coverage.
Conclusion: I Am Not Buying Air Wisconsin Stock
Whether you consider Harbor Diversified stock a buy really depends on your risk appetite. Clear risk indicators are the relatively low price, low market cap and the lack of management guidance as there are some big changes to the business this year. Furthermore, the company has a negative enterprise value, indicating that its cash and assets are not utilized efficiently, which leaves us to value the company on net cash and securities providing some upside in the high-single-digit range, but I don’t quite see it as being enough to offset the risk factors.
For further details see:
Harbor Diversified: Upside Remains But Risks Reduce Appeal