Description

Atlas Air Worldwide Holdings (AAWW), an air cargo operator, is an undervalued and misunderstood post-reorg equity with significant free cash flow (17% FCF Yield!) and strong growth potential. AAWW is the largest operator of 747 freighters in the world and operates 4 primary businesses through its two subsidiaries Atlas Air Inc and Polar Air Inc. The company currently operates 39 747 freighters.

The four businesses are as follows:

- ACMI (54% of ytd block hours)- Atlas Air provides Aircraft, Crew, Maintenance and Insurance (ACMI) leasing to a variety of airlines worldwide. Under an ACMI contract customers receive a dedicated aircraft which is crewed, maintained and insured by Atlas in exchange for an agreed level of operation. Atlas is paid a fixed hourly rate for the time the aircraft is operated. All other direct operating expenses of operation, such as fuel, landing fees and ground handling are absorbed by the customer. The customer bears the commercial risk of load and yield. NO FUEL EXPOSURE!!

- Polar Air Cargo (25% of ytd block hours) – Polar provides scheduled cargo services to the world’s largest freight forwarders. Polar operates airport-to-airport specific routes on a specific schedule, and customers pay to have their freight carried on that route and schedule. Polar’s scheduled all-cargo network serves five principal economic regions: North America, South America, Asia, the South Pacific and Europe. In addition, last year Polar was awarded the first new incumbent rights for China-US scheduled service, which has been very strong. Polar has 9 flights per week now rising to 12 next march. The only other carriers currently allowed to provide similar service are Fedex, UPS and Northwest cargo. Only northwest cargo is a true competitor since FDX and UPS are focused on parcel not freight. Some fuel exposure but expect a 60% passthrough or so (tied to Lufthansa index which most freight guys use).

- AMC (18%)– AMC is the military charter business. The US military has always supplemented its in house lift capacity with outside carriers. Atlas is a member of a team led by fedex entitled to 47% of all widebody US military business, currently Atlas gets a larger share of this business. The US Military pays full fuel cost plus a very healthy and profitable margin to Atlas and other carriers for this business. NO FUEL EXPOSURE.

- Charter (4%) – Atlas also provides charter service to certain clients. In these cases Atlas gets a very healthy market rate plus all fuel costs paid for. NO FUEL EXPOSURE.

Atlas emerged from bankruptcy in June 2004 and is significantly exceeding plan estimates for 2005 on both the revenue and EBITDA. Atlas filed for bankruptcy after 3 years of weak demand in the air cargo sector. The main causes for this were the global recession, terrorist attacks, frontloading of tech equipment purchases by Y2K and the general tech bubble. In 2001 air cargo demand decreased for the first time ever vs a historical and projected growth rate of roughly 6.5%. Air cargo strongly recovered in 2004 and had a good year in 2005 as supply and demand tightened. We believe Atlas is an excellent way to play increased global trade and more importantly the tight supply and demand situation for widebody jets in the future.

The company’s businesses are all significantly profitable and have no fuel exposure except for the Polar air cargo business. Polar is the unit that operates scheduled service routes globally. Because other units are more profitable, Atlas has rationalized its fleet out of the Polar business and into the ACMI business. Currently Polar has 6 planes versus more than 12 previously. This also significantly lowers the fuel exposure of the overall company.

As a side note - about 2 weeks ago the Polar pilots went on strike and from my standpoint this was surprisingly a good thing for Atlas. While the polar pilots are back on the job now, management made it very clear that if they did not accept the management offer, Atlas would shut down polar and sell the routes. We estimate the routes to be worth north of $200m, and since they make no EBIT and we could reallocate those planes into ACMI, a sale of the polar routes would be a hugely accretive trade. However, there is something to be said and synergies to be gained in having a scheduled service business so management has decided to keep the Polar business if possible but has shown it is willing to close/restructure it if necessary.

The company has yet to be a timely SEC filer but provides monthly operating statistics and issues quarterly press releases detailing earnings. Looking at these numbers we can see that it is well ahead of its plan projections (shown below). We believe EBITDA will be north of $200m vs a plan projection of $159.6m and believe 2006 EBITDA will be even higher. The company has also stated during conference calls that it expects to be well ahead of plan.


2004E 2005E 2006E 2007E
Total Op Revenues 1,156.4 1,179.2 1,215.4 1,238.6
EBITDAR 224.8 287.2 332.2 340.3
EBITDA 83.6 159.6 199.1 207.4
EBIT 46.2 122.2 161.7 170.0

The company has 22.7m diluted shares outstanding and at $31.00 per share this equates to a $705m equity value. The company has $725m in debt and approximately $221m in cash (pro forma for trust and insurance payments received after the Jun 30 quarter).

If we assume only $200m in EBITDA for 2005, $50m in interest and $30m in cap-x we get a Free cash flow of $120m for 2005 or a 17% Free Cash Flow Yield. The company came out of bankruptcy with “several hundred million dollars” in NOLs and says it will not be a cash tax payer until sometime in 2007. The company is currently trading at 6.0x 2005 EBITDA, 7.3x EBIT,6.8x EBITDAR and 9.8x 2005E P/E, which seems quite cheap to us. There are really no solid comps for Atlas but we believe Atlas should trade around 7.5x EBITDA which yields a $44 stock or about upside of 40% from the current price. In addition –we think Atlas is capable of doing $225m in EBITDA in 2006.

Supply/Demand

The current rate environment for ACMI services is dictated by the tight supply/demand situation for widebody freighters in the world. Demand is driven by a variety of factors most notably global trade. Global air cargo trade is expected to increase at 6.5% for the next 20 years (source: Boeing) with the majority of that being in widebody freighters as international trade increases. Supply is coming online slowly as Boeing makes only about 3-4 747-400 freighters per year, and at a cost of $200m. Most increases in supply are in the form of converted 747s or 777s but conversion kits have just started being available for the newer 400 type planes and any increases in demand are being used mostly to replace existing 747-200 freighters that are old and less fuel inefficient. Boeing has sold out conversion slots until 2009. The only other company to offer conversion is Israel Aircraft industries, but they are not slated to start conversions for a few years. Atlas currently has conversion slots for 4 aircraft with Israel and options for 6 more from 2009-2011.

We and the company believe that the tight supply for widebody jets will continue and demand will outpace available supply for the foreseeable future. As a result, ACMI lease rates will continue to increase. In fact – the CEO of emirates freight has said that no 747-400 freighters are available in this market!

NOTE: One other point that comes up is the threat of the A380 on demand for 747 freighters – the A380 is not likely to be a strong replacement for the 747 freighter due to weight characteristics. It will likely be very good for parcel delivery but not as good for large freight pallets. The recent orders of Cargolux and UPS for 747 freighters show the willingness of freight carriers to continue use of the 747s as the workhorses of their fleet.

The AMC business has been buoyed by the current military initiatives and wars in Iraq and Afghanistan. However even during peacetime, Atlas supports the Air Mobility Command with widebody freight services. While it is certainly running ahead of plan, even if this business slows down, Atlas could easily place those jets in the ACMI business quite easily. Because the military business is more profitable, Atlas would prefer to have as many jets in AMC as possible rather than deploy them into ACMI. In fact – Atlas has said that it rejected approximately 12 aircraft in bankruptcy and if they had those jets today – they could place them in ACMI contracts at very attractive rates.

Growth

As Atlas’ ACMI contracts start to roll off into a stronger market they can renew these leases at significantly higher rates, all of which flows straight to the bottom line.

Polar air cargo will continue to grow as scheduled service demand continues to stay high. The US-China restricted route rights and very good routes and have high growth, and Atlas is getting great pricing and fuel cost passthrough for this freight. In addition, 3 more weekly flights will be added starting in March 2006. Either way – Polar is becoming a much smaller piece of the overall business as Atlas moves more planes into ACMI.

Fleet

Atlas has approximately 19 747-400s of which 6 are owned and 13 are leased on approx 20 year useful lives. It also has 20 747-200s of which 16 are owned and 4 are leased. In bankruptcy Atlas was able to reject leases on almost all of its unprofitable/oldest planes. Having said that - even these planes in todays market would be flying on profitable ACMI contracts. In addition, atlas performed C and D checks on the majority of its fleet in the last 2 years yielding huge maintenance savings going forward.

Catalyst

- Timely filing of SEC documents
- Listing of stock on an exchange
- Roadshow by management upon listing
- Continued rationalization away from Polar and into Atlas ACMI
- Possible cash distribution