Description

We originally recommended VIC users purchase Atlas Air (AAWW) in October at $31.00. While the stock has moved more than 50% to $47.50, we still feel there is significant upside remaining in the name (possibly more than 50%). Please read our original VIC piece for a detailed analysis of each Atlas business and prospects. Below we have simply updated the valuation for recent announcements and 2005 performance and highlighted why we still think it is cheap.

For those who are not familiar at all with the name, Atlas is the largest operator of 747 freighter aircraft in the world. The company operates 39 747 freighters on ACMI leases (no fuel exposure), Military Charter (no fuel exposure) and Scheduled service businesses (some fuel exposure). The company emerged from bankruptcy in June 2004. PLEASE READ THE ORIGINAL VIC PIECE FOR FULL DETAILS of each segment, prospects, etc.

Since the original VIC write-up , two announcements have furthered our conviction (and upside targets) in Atlas:

First, when we wrote the piece in October we highlighted that the company, in our opinion, should easily exceed our expectation of $200m in EBITDA for 2005. In fact, our estimates proved overly conservative as the company has recently announced pre-tax income exceeding $125m for 2005, which implies roughly $240m in EBITDA for FY2005. The company also generated significant amounts of cash flow, closing the year with $305m in cash, more than $15 per share.

Second, in December, the company highlighted that it has identified potential cost-savings and revenue enhancement opportunities that could benefit AAWWs operating performance by $100m over the next several years. AAWW also noted that the “prospective savings and revenue enhancements that could be realized in 2006 and 2007 would not be insubstantial”, meaning that it would not likely take long to realize some of the planned savings.

The 2005 EBITDA does not reflect any of these expected $100m in cost savings. We will leave it up to VIC readers to interpret the “not insubstantial” comment by management, but our estimate is for approximately $20-30m of these savings to be reflected in 2006 (primarily low hanging fruit). If we add the midpoint of this ($25m) to our 2006E EBITDA number of $250 you get $275m in EBITDA and approximately $240m in EBITDA-Capx. These give 2006E multiples of 5.0x EBITDA and 5.8x EBITDA-Capx. We believe the right multiple for this business is 7.0x forward EBITDA, based on various transportation, leasing and airline comparables. However, we will admit there is no good comp for Atlas. Note: while they are all air cargo businesses we do not think ABX Air, Evergreen or World Airways is a strong comp for Atlas (see our original post for reasons). Using 7.0x as our fair market multiple, we get a stock price of $73! Or 54% further upside in the name.

In addition, at $275m in EBITDA assuming capx of $35m and net interest expense of $68m and keeping in mind the fact that Atlas has hundreds of millions of dollars in NOLs and will not pay cash taxes until 2008, the FCF generated by the business is $172m. Given today’s equity value of $980m, that implies a 18% FCF yield. The significant cash generation ability by Atlas is evidenced by the $305m of cash on the balance sheet at year end 2005 vs $134m at year end 2004 (note: $12m in 05 was insurance proceeds). At current valuations Atlas trades at 7.3x 2006E EPS or 6.0x CEPS which is way too cheap in our opinion.

Given the high FCF yield, it is not surprising that there are rumors circulating that the company is for sale. While we put only a small amount of credence in these rumors, it is important to point out that the routes into Narita, Japan and the exclusive rights Polar owns into China are extremely valuable (we conservatively estimate north of $200m) and could be sold separately from the ACMI business. Given that they contribute a nominal amount to EBITDA, it would be hugely accretive to sell these routes and put those existing planes in ACMI. In our opinion, Atlas is an attractive candidate for any shipping operation looking to gain valuable Asian routes and a highly desirable fleet of 747-400 aircraft, of which Atlas is the largest operator. 747-400 freighters are in very high demand right now, with current demand exceeding available supply. Further, Atlas’ 400s are all original freighters built 1998-2001 with nose doors,etc (not conversions). Current list price for a new 747 freighter is north of $250m.

We think there is easily a case for an additional 50% upside in the name and possibly more if ACMI rates continue to rise or the company exceeds our cost savings estimates. Other upcoming catalysts include the company becoming a timely filer of SEC documents which will soon lead to the shares being listed on an exchange. Management has committed to getting the story out and possibly doing a non-deal roadshow, so that investors can better understand the business model. In addition, for investors looking for a china airfreight play, Atlas is one of the few (if not only) options.

Catalyst

- Listing on exchange
- Timely filing of SEC documents
- Significant FCF yield (18%)
- Possible sale of business or polar routes