Description

Summary:

Do you believe that, with the USD/JPY exchange rate at 123, Japan is the best value for money tourist destination in Asia, if not the world?

Do you believe that inbound tourism to Japan will continue to increase from its low base as we near the 2020 Tokyo Olympics, given A) its proximity to big spenders from China/Hong Kong/Taiwan, and B) the Japanese government’s willingness to relax visas as well as duty-free shopping,?[1]

If you answered yes both questions, then owning a monopolistic airport business like AGP (short for Airport Ground Power http://www.agpgroup.co.jp/en/) at the below valuation multiples given its recent shift to shareholder-oriented management makes a lot of sense if you can ignore what we feel are the two key reasons its cheap: illiquidity (just 17% free float, until last month it cost USD 3,000 to own a one board lot, etc.) and obscurity (until mid-2015 there was 0% foreign shareholding and only 500 total shareholders, with zero investor relations for years).

·       11x 2015 P/E (3.8x 2019 P/E, based on the company’s forecast)[2]

·       2.6x 2015 EV/EBITDA (1.5x 2019 EV/EBITDA, based on the company’s forecast)

·       73% discount to the original asset replacement cost of just one of its business segments

·       A 41% discount to the cumulative EBITDA minus capex (or 5% discount to the cumulative FCF) over the last 10 years alone, which was a period of significant headwinds (i.e. Lehman, Fukushima earthquake, JPY strength, etc.)    

5 year company forecast: revenue, EBIT, net income, ROE% (in JPY billions)[3]

FY2019 (3/2020): 15.43, 2.05, 1.15, 12.2%

FY2018 (3/2019): 14.45, 1.84, 1.05, 12.3%

FY2017 (3/2018): 13.35, 1.38, 0.78, 10.0%

FY2016 (3/2017): 12.08, 0.90, 0.53, 7.3%

FY2015 (3/2016): 12.00, 0.80, 0.46, 6.6%

2006/03/31 – 2015/03/31 ten year P&L record:

Peak revenue: JPY 12.062 billion                            Trough revenue: JPY 10.091 billion

Peak EBITDA: JPY 1.854 billion                  Trough EBITDA: JPY 1.403 billion

Peak EBITDA %: 16.4%                                Trough EBITDA %: 13.4%

 Background:

AGP was founded in 1965 and IPO’d in 2001.  Its major shareholder since inception has been Japan Airlines (current shareholding: 33%), and over the years both All Nippon Airways and Mitsubishi Corporation bought significant stakes (they now own 27% and 20%, respectively).  Japan Airlines has maintained management control of AGP since inception.  The current President of AGP and several other senior executives were seconded from Japan Airlines in 2013 to implement a new growth strategy (more on this below).   

Power supply business:

The core power supply segment is essentially a toll gate on idling aircraft at the 9 largest airports in Japan.  The business model description (see home page http://www.agpgroup.co.jp/en/power_supply_business.html) is below:

“The Power Supply Business deals with providing power (electricity / conditioned air / compressed air) to the aircraft, and design, construction, operation and maintenance of aircraft-power supply facilities.

We provide power for aircraft, i.e. electricity, conditioned air and compressed air, using two methods.

Currently, the major form of supplying power is with the facility called Fixed GPU (Ground Power Unit). By building a power plant on the airport premises, which has the ability to receive and distribute electric power and a heat source, the facility receives the commercial electric power supply from the power company, and provides the cold water / hot water and electric power to the equipment at the aircraft parking spot. The equipment at the aircraft parking spot converts the electricity to aircraft-use, and supplies conditioned air made out of the cold water / hot water for the aircraft.

The other form of equipment is the Mobile GPU, which is a vehicle used to provide electricity / conditioned air / compressed air at aircraft parking spots where no Fixed GPU is available. This is widely used at aircraft parking spots and local airports, where no Fixed GPU is available. 

AGP has almost exclusively equipped approximately 300 Fixed GPU units in the following 9 airports: Chitose (Sapporo), Narita, Haneda, Itami (Osaka), Kobe, Kansai, Hiroshima, Fukuoka and Naha.” 

There are two ways aircraft can obtain power (electricity and air-conditioning) while idle on the runway when the main engines are off.   The first way is to burn fuel and rely on auxiliary power units (APU, or the small jet engines in the tail of an aircraft that are used to deliver electrical power and air conditioning to the cabin while the aircraft is on the ground with the main engines off), an expensive and environmentally unfriendly option that enables quicker turnaround times.[4]  The second way is what AGP provides its airline customers – the ability to plug into a fixed or mobile ground power unit (GPU), which is cheaper (by up to 90%) and more environmentally friendly than APU, but requires slower turnaround times.     

To alleviate public concerns about air/noise pollution, governments everywhere are demanding that idling aircraft rely less on APU and more on GPU.  For example, the Airport Authority Hong Kong has banned APU usage since 2014 when aircrafts are in stand-by mode and upgraded their existing GPU infrastructure to compensate for that (see page P4 http://www.cleanair.hk/eng/certification/report/rep_airportauthority.pdf).

              AGP’s power supply business is steady (segment EBITDA margins since ’09: 24-30% thanks to cost-plus pricing) with adequate but unexciting returns on capital (since ’09 segment pre-tax ROA averaged 9%) but high barriers to entry (i.e. even if new entrants could obtain approval to compete, the original cost of AGP’s equipment was JPY 19 billion or almost 4x its market cap today).  With certain exceptions such as All Nippon Airways or FedEx (which own some of their GPUs), most of the airlines at Japan’s 9 largest airports must pay AGP a per-minute fee for the right to plug into their GPUs.

              While it may vary depending on the specific type of aircraft, the per-minute fee that AGP charges for GPU power is currently about JPY 100.  Large commercial aircraft tend to plug in for as long as 40-50 minutes, while small low-cost carriers might plug in for 20-30 minutes (if they do plug into GPU power at all – most prefer to use APU).  The cost of that GPU power, which AGP procures from regulated electric utilities like Tokyo Electric Power, is currently about JPY 20-30 per minute thanks to lower oil prices.  Though AGP does not adjust GPU pricing day to day (or even month to month), they have historically hiked prices when their margins are pressured from higher electricity procurement costs.  That’s why the power supply segment has historically been able to maintain an EBITDA margin of 24-30% since 2009.  This year, AGP’s power supply business is actually benefiting from stable pricing but lower electricity procurement costs.[5]  Customers haven’t been whining to AGP to lower their GPU prices either.  Why?  Since the cost of GPU power for a single plane might only be JPY 4,000-5,000 yen (40-50 minutes * 100 yen/minute), this is a miniscule amount of money relative to the overall P&L of the flight and probably not the first thing on the minds of AGP’s customers.

              The most exciting aspect of the power supply business for AGP shareholders is growth potential.  In other words, the more flights that fly to/from Japan, the more revenues this business segment will earn.  Though the number of flights to/from Japan have not increased as much as the number of foreign tourists have (i.e. total inbound tourists in Jan-Sept 2015 grew 49% YoY), flights are gradually increasing as existing route capacity fills up.[6]   For example, Dragonair started daily flights to Haneda Airport from Hong Kong in March 2015 – their planes now generate incremental GPU revenue that wasn’t there in 2014.[7]  Likewise, Haneda Airport (22% of AGP’s consolidated revenues in 3/2015) just announced extra flight slots to/from China, a big surprise to us given that the airport’s management previously described capacity utilization as having already reached “the upper limit.”[8]  AGP clarified that what Haneda is really doing is cutting back on domestic flights in favor of international flights, so the total flight capacity of the airport will remain unchanged.  From AGP’s perspective, however, the addition of international flights should provide a boost to their GPU business, since those flights tend to plug in for much longer times than short-haul domestic flights.  

The Japanese government has been extremely supportive of inbound tourism overall since 2013 (i.e. relaxed visas, duty-free shopping, etc. already doubled inbound tourists from 2012-2013 levels).  In November 2015 the government deepened their commitment to tourism by A) slashing landing fees at many regional airports and B) increasing the annual inbound tourist target by 50% to 30 million.[9]  Given the low base Japanese tourism is starting from – despite having the world’s 10^th largest population and the city with the most Michelin starred restaurants, in 2014 the country attracted fewer tourists than 20 other mostly smaller countries – we think additional growth in tourists is possible.   

How much growth is possible?  AGP management conservatively estimates revenues for the power supply business should grow at least 31% from FY2015-2019.[10]  Management feels this estimate is conservative because the current utilization rate of GPUs at the 9 airports AGP serves was only 62.5% in FY 3/2015.   Why was utilization that low?  First because low cost carriers, the major source of growth in tourists to Japan lately, have continued to favor APU power due to the shorter turnaround times it enables despite official guidance to switch to GPU power.[11]  Second, Japan Airlines temporarily halted using GPU power for their new Boeing 787’s in 2014 due to concerns about their effect on the batteries (those concerns were later resolved and the 787 is back to using GPU power now, a big reason why YTD revenues have grown).  AGP management feels that a normalized level of GPU utilization across all their airports should be at least 80% (Japan Airlines itself is already over 90% GPU utilization) once low cost carriers fully comply with air pollution regulations.  Globally, low cost carrier GPU utilization is around 30%, but in Japan it was only in the teens % last year.   Thanks to successful negotiations with certain low cost carriers, AGP’s GPU penetration has hit 25% of all low cost carriers this year. 

In short, AGP’s power supply business is poised to grow from increased flights to/from Japan thanks to booming inbound tourism, but even if that doesn’t pan out (perhaps the JPY won’t remain this weak) there should still be meaningful growth from higher GPU utilization related to stricter environmental compliance.

Maintenance business:

AGP’s maintenance segment, which deploys hundreds of technically qualified engineers (all full-time staff with over 10 technical qualifications per person) to fix problems and source replacement parts 24 hours a day at Japan’s 9 largest airports, is asset-light (pre-tax segment ROA averaged 66% since ‘09), sticky (80% of revenues are based on fixed 3-5 year contracts with airports/airlines), and cash generative (this segment generated 50% of AGP’s cumulative EBITDA minus capex from ’09-’15).  The segment description below is taken from the home page (http://www.agpgroup.co.jp/en/maintenance_business.html ):

The Maintenance Business provides maintenance for buildings, various facilities and special auxiliary equipment.

System Maintenance Department

The System Maintenance Department contributes to the on-time operation of aircraft through the maintenance of airport facilities necessary to support aircraft arrival and departure, such as passenger boarding bridges, baggage handling system and automated warehouse for aircraft parts. 

The passenger boarding bridge is an important connection between the passenger terminal and the aircraft. The baggage handling system carries the important OR valued passenger baggage into the aircraft hold, safely and smoothly. The automated warehouse handles the entry and exit of essential aircraft parts efficiently. We handle and maintain these facilities with the highest levels of technical expertise. 

In addition, utilizing the experience and knowledge we have accumulated through operations in the airport, we are also conducting maintenance and operations off-airport, such as for logistics centers. 

Facilities & Equipment Maintenance Department

The Facilities & Equipment Maintenance Department provides maintenance for airlines’ support facilities, such as aircraft hangars, cargo warehouses, in-flight catering facilities, cold and heat source supply facilities, high voltage electricity conversion plants and hotels, etc. 

Considering the business environment at the airport, our maintenance services are seamlessly provided 24 hours a day.

For safe operation of the aircraft, the support of many people in various fields is essential. Our Facilities & Equipment Maintenance Department provides a hospitable environment by maximizing the potential of buildings and facilities to support the people working at the airport, so that they can smoothly carry out their duties. 

              Though there is competition for aviation maintenance work, most of AGP’s maintenance revenue comes from maintaining the passenger boarding bridges and baggage handling systems, areas where AGP has a strong reputation and greater than 50% market share at the 9 major airports they operate in.  By airport, the largest revenue contributors to the maintenance segment are Narita, Kansai, and Haneda.  The growth prospects for the maintenance business more limited than the power supply business, but AGP management has made progress on some new businesses that are similar in nature.[12] 

The first of these is the security business, which maintains and operates the checked baggage security system at Narita Airport.  According to AGP management, though the security revenue forecast is flat through 2019, this segment should see a step up in growth from 2020 when new equipment arrives to facilitate the influx of tourists for the Tokyo Olympics. 

              The second of these is the business jet (private jet) cleaning business, the only one of its kind in Japan now.[13]  This business utilizes AGP’s business jet hangar at Narita airport (the only one that exists today) to charge both parking fees and cleaning fees.  Overall, parking/cleaning are only estimated to generate JPY 60m in revenue to start, but the margins and returns on capital will be high.  AGP management expects demand to pick up as Japan becomes more of an international destination for business jet owners.  As has been reported widely, Japan is far behind the United States and Europe in terms of business jet usage/friendliness, but AGP management feels the industry is finally gaining acceptance.[14]

Shareholder-friendly management installed in 2013:

In June 2013, Eichi Yamaguchi was sent from Japan Airlines to become president of AGP.   Since he took control (with several other Japan Airlines veterans), AGP seems to have sharpened its focus on growth and shareholder value creation.  The publicly stated goal of more than doubling net income within five years, the October 2015 stock split to reduce the minimum investment per board lot by 90% and enhance trading volume, and the proactive initiation of investor relations activities (Nomura helped management host  their first IR day for individual investors on 27 October 2015) are all positive signs for minority shareholders of AGP.  We have been impressed with the level of transparency, too: management has chatted with us (in English) on multiple occasions in person and by phone and responded very quickly to any emailed questions.  Without any prompting, management even custom-made an English translation of their most recent annual investor presentation just for us (according to them, no other investors have reached out for 1x1 interaction).[15] 

In the long-run, management understands that in order to get a fair valuation by the stock market, their major shareholders (Japan Airlines, All Nippon Airways, and Mitsubishi) need to sell-down a block of shares and increase free-float.  Of course, none of the major shareholders will agree to sell at the current depressed price.  So this problem can only be solved if the stock price heads higher, and that’s why management has been taking steps to improve investor relations.   

Valuation: cheap any way you look at it

In our opinion, AGP is cheap any way you look at it, especially given the current boom in Japanese inbound tourism.  AGP’s market cap of JPY 5.2 billion today is not only ¼ of its original GPU equipment cost, it’s even less than the cumulative free cash flow (OCF minus capex: JPY 5.5 billion, EBITDA minus capex: JPY 8.7 billion) generated in just the 10 years ending March 2015 – years with headwinds like the 2011 earthquake.  If Japan’s tourism tailwinds mean AGP management’s five year forecasts prove correct, then AGP is trading at just 3.8x 2019 P/E (and an even lower multiple of 2019 FCF).  If management’s forecasts prove incorrect, then AGP is still trading at undemanding prices: 11x 2015 P/E and 8x EV / average FCF for the last 10 years.

AGP is the only publicly listed aircraft GPU power supplier that we know of.  The closest comparable to AGP that we could find is Thai Airways-controlled Bangkok Aviation Fuel Services (BAFS TB), which provides aircraft refueling services at Thailand’s major airports.  We haven’t met with BAFS management, but it appears to trade at much fancier multiples than AGP (19x earnings and 3x book) without the similarly rosy growth outlook (thanks to coups, bombings, etc. Thailand attracted fewer foreign tourists in 2014 than in 2013, but that’s still double the total Japan attracted over the same period).

Risks:

The most immediate short-term risk facing AGP is the likely privatization and change of control at Kansai International Airport, which has declared a consortium led by Orix/Vinci as the preferred bidders http://www.orix.co.jp/grp/en/pdf/news/151110_ORIXE2.pdf.   Last year, revenues from Kansai Airport generated JPY 1.8 billion of AGP’s JPY 10.7 billion in consolidated revenue.  Roughly 1/3 of this was from the GPU business and the remainder was from the maintenance business.  If Kansai Airport’s new owners decide to kick out AGP from Kansai Airport, then that would be a meaningful, but not catastrophic, blow to AGP’s P&L.  So far AGP management has heard nothing about possible changes to their business at Kansai Airport, and in their opinion Orix/Vinci will be most focused on creating non-aviation upside (i.e. more duty free shopping space for Chinese tourists) at the passenger terminals as opposed to messing with GPU power suppliers or baggage claim systems.

In the long-term, AGP management highlighted some technological risks to both their GPU and maintenance businesses.  The long-term threat to GPU power suppliers is improved onboard battery power technology, such that idle planes won’t need to rely as much on external power supplies or APU fuel.  AGP management could be wrong about this, but their impression based on the latest aircraft models they service is that the threat of superior batteries is still decades away.   A possible, but perhaps remote, long-term risk to the maintenance business is the usage of robots at Haneda and other airports.  Haneda began testing robots for certain manual labor tasks this year, but AGP management indicated that it could be a long while before the robots can replace their trained engineers in solving ad hoc problems with the boarding bridges and baggage systems.[16]

Catalyst

Catalyst:

Growth from additional flights

Growth in Narita/Haneda airports after 2020 (i.e. Narita airport has hinted to the public that they will add another runway, which will necessitate the addition of another passenger terminal)

Long-term possibility of getting business beyond the 9 biggest airports

Increased dividends in line with higher ROE policy