Description

ABX Air (ABXA) was created from the recently complete merger of Airborne Express and DHL. Coinciding with the merger (due to federal law restricting non-US companies owning a US based airline) Airborne spun-out its air division to its shareholders. Old Airborne shareholders received $21.25 in cash and one share of ABXA for each share of Airborne.

Pro forma revenues (discussed more below) for the company for 2002 were $967 mil, which generated $25.8 mil in operating income. Over 98% of its business was related to Airborne Express (it was, after all, Airborne’s wholly owned airline). And, the newly combined DHL/Airborne will provide most of its business for the foreseeable future.

Investment Thesis

The long investment thesis for ABXA stems from the following:

Strong and continued relationship with ABF (and now DHL)
Being the former company owned airline of Airborne, ABX is ingrained in Airborne’s system, and Airborne is completely dependent upon ABX. While having one customer provide such a high percentage of revenue has obvious risks, the relationship between the two is, by necessity, quite strong. Hence, the consistent revenue stream and cost plus nature of the contract (discussed more below) provide tremendous stability for the company going forward.

Increased opportunities from DHL’s acquisition of ABF
DHL is the world’s largest express and logistics company. For years, it has tried to find an entry into the US, and with the ABF transaction it has found one. In theory, the combination of the two companies should provide significant growth for Airborne’s (and by default ABX’s) domestic operations. The total impact on ABX is difficult to say right now, but it can be assumed if anything, it is a positive – and potentially a large positive. Of note, DHL’s US business prior to the merger was roughly one-third of Airborne’s business. ABX should at least see an increase in volume based solely on DHL’s traditional US business.

Potential for expanded third party business
In 2002, third party business provided 1.7% of ABX’s total revenue. However, it provided 11.8% of the company’s operating income (pro forma). With its much higher margins, increased business in this segment would provide significant margin expansion and earnings growth. While growth in this segment should not be huge, ABX should have a somewhat easier time generating revenues from non-ABF sources now that it is an independent company. And, this is an area ABX management will be focusing on going forward.

Hidden earnings potential
ABX’s contract with Airborne is a cost plus contract that covers all costs (including financing costs) to provide services to Airborne. It does not cover income taxes. The base case, and the case ABX’s pro forma figures are based on, is a 1.75% markup over its costs. However, ABX has the opportunity to expand this markup, up to a possible 3.35% under its ACMI agreement and 3.85% under its hub services agreement, which could make quite a difference to the bottom line. For example, pro forma EBITDA for 2002 was 54.4 mil based on the 1.75% mark-up. A 2.25% mark-up coincides to 57.5 in EBITDA; 3.00% a 62.0 mil EBITDA.

Valuation:
ABXA looks cheap from numerous perspectives based solely on past pro forma numbers. Future results could significantly outperform these pro forma numbers as DHL and third party business grow. However, since the impacts are basically unknown, the valuation below is based on past pro forma results and rough ‘ongoing’ estimated numbers that do not try to quantify the DHL impact. (Pro forma numbers are more relevant here than actual results because the pro forma numbers are based on the contract that will be used by Airborne and ABX going forward. Actual results were not based on this agreement.) Anyway, here are the two ways I look at the valuation:

1) EV/EBITDA
As stated above, pro forma EBITDA for 2002 was roughly 54.4 mil. I project EBITDA for 2003 to be at least 60 mil (based primarily on the markup percentage increasing somewhat). Depending on how you want to value the off balance sheet leases and if you want to subtract out the cash on the balance sheet (I don’t), you can get varying debt figures. A conservative figure, in my opinion, is 175 mil. With a mkt cap of 96 mil, you have an EV of 271 mil which translates into a 4.5x EV/EBITDA multiple. Seems pretty cheap. A 6x multiple gives you a $3.50 stock price.

2) EPS
Pro forma EPS for ABX in 2002 was $.31. However, this number is inflated, as it does not include income tax. Fully taxed, and the number is closer to $.19. Using the 60 mil EBITDA from my forecast above, a fully taxed number for 2003 looks like $.25. A possible (I would say entirely probable) ‘normalized’ EBITDA of 65 mil translates into EPS of roughly $.30. Based on the current price of $1.85, you are looking at a forward P/E of 6.2 to 7.5 – a historical P/E of 9.7. Not a bad place to buy a company with moderate to substantial upside business potential. A 10 P/E based on my 2003 estimates translates into a $2.50-$3.00 stock.

Through either analysis, the company appears to be undervalued at its current price regardless of the DHL or third party impact. Throw in some meaningful business from either source, and EBITDA going forward could be substantially higher than 60 or even 65 mil. As an example, as stated above old DHL did roughly one-third the business old Airborne did in the US. Just adding that volume to ABX drives EBITDA up to 65 mil and lowers the EV/EBITDA multiple down to 4.2 without markup improvement or increased third party business. A 6x multiple on 65 mil gives you a stock price north of $4.00.

Conclusion
ABX is a cheap company based on historical returns with decent growth opportunities. If the company’s operations remain stable going forward, a case can be made that the company is worth $3.00 or so, a nice return from the current $1.85 price. However, the exciting part lies in the growth opportunities provided from the DHL/Airborne merger, the company’s ability to increase the markup percentage in its contract with DHL/Airborne, and its ability to increase its focus on third party business. Positive performance from any of those situations could increase operational performance substantially and provide a stock price far beyond $3.00.

Risks:
ABX operates in the air parcel delivery business. Risks inherent in the business include periodic large capital expenditures required for planes and airport construction. ABX is obviously vulnerable to these risks, but not more so than any other industry participant.

Specific company risks for ABXA include:

Dependence upon one customer
This is the primary risk of the thesis. DHL/Airborne should provide over 95% of the company’s business for the next few years, at least. A DHL/Airborne stumble or the termination of the contract (not realistically possible for at least 7 years) would obviously negatively affect ABX.

Catalyst

Increased volumes from the DHL/Airborne combination
Increased ‘third party’ business
Increased markup percentages from operational improvements
Recognition from the investment community
Listing on a national exchange