Description

Dart Group is a very interesting company based in the United Kingdom that operates two businesses: air travel from the UK to leisure destinations (and night carriage of Royal Mail) and produce distribution throughout the UK. 

While I have never invested in an airline before and was reluctant to do so initially, there is significant comfort in the fact that with a GBP 73M market cap, you have GBP 16M of net cash, tangible book value in mostly owned aircraft of GBP 106M and a profitable distribution business that we think could conservatively sell for GBP 30-40M and conservative EBITDA estimates of GBP 40M per year, valuing the company on 1.2x EBITDA and a 28.5% conservative FCF yield.  Finally, 40% of the company is owned by Philip Meeson who lives and breathes this business and has the majority of his net worth tied up in the company's stock, which is down from 150p in early 2007 to 50p despite better profitability and net cash versus a previous net debt position. 

The company's airline business is reminiscent of Allegiant Travel Company (ALGT) which flies from small airports to popular vacation destinations, avoids direct competition with other airlines, derives a significant percentage of its revenue from ancillary charges; that company  trades for 5.5x 2010E EV/EBITDA,  making Dart Group's valuation even more compelling.

Description

Dart Group is made up of two distinct businesses: a leisure airline that provides services from several UK airports to leisure destinations throughout Europe (as well as night service for Royal Mail) and a business that distributes produce within the UK.

The majority of the earnings come from the airline business, called Jet2.  While passenger air travel is ordinarily an unprofitable business over the cycle, Jet2 has managed to be profitable and cash flow positive throughout the current crisis and currently generates ROIC of  over 20%. 

The business model is relatively simple: avoid competing with larger competitors on the majority of their routes. By operating from specific, smaller airports (Leeds, Manchester) and being in many cases the primary operator out of that airport, they are generally in a position to offer the most convenient, low cost option for travelers headed to leisure destinations.  Despite additional competition in some of their markets that has developed over the most recent six months (namely Ryanair increasing their presence in Leeds), Jet2 still continues to have the most convenient and often lowest cost option from their airports.  In addition, recent indicators point to a relatively strong booking season in January and February for summer travel in the UK which gives us further comfort.

In addition, they keep their overall cost structure low.  This is accomplished by intelligently purchasing older aircraft at low or distressed prices and generating higher utilization than competitors by flying passengers during the day and providing service to the UK's Royal Mail at night in their easily converted aircraft.  In addition, by purchasing the majority of their aircraft at good prices without using debt, they are able to gain an overall cost advantage over competitors which buy new planes, pay more money for them and have high cost debt to service (or they lease them, which carries high operating costs as well).  They also generate bookings further in advance than other low cost carriers (by being travel agent friendly and offering leisure services often booked further in advance), which effectively gives them float for several months before actually providing the flight to their passengers.  Finally, Jet2 derives a significant amount of their earnings through on-board spending for everything from more leg room to additional baggage charges and have been very successful in recent years of increasing on-board spend per passenger from GBP 9.10 per passenger in FY2008 to above GBP 20 per passenger in 1H10.

Overall, we expect this division to generate GBP 40M of EBITDA with some potential for growth if the UK market improves as indicated by recent booking trends in the UK.

The other side of the business is their Fowler Welch-Coolchain division which distributes produce throughout the UK.  This business is also profitable, generating GBP 4-6M of EBITDA per year.  This business within the UK continues to consolidate and we expect with the CEO's focus being on Jet2 that this business might ultimately be sold.  Based on its relatively consistent earnings stream (management has said they usually know what they will earn for the year by the time the year starts), we think this business could easily sell for GBP 30-40M, giving us further comfort on our downside with this company.

Therefore, we see the current valuation as follows:

Market Cap: GBP 73M (at 50p per share)

Net Cash: GBP 16.1M (GBP 16.5M of cash less 0.4M of debt)

Value of Distribution: GBP 35M

Value ascribed to Aviation: GBP 22M

EBITDA 1H10 (Six months ended 9/30/09): GBP 42M (of which Aviation represented approximately GBP 39M).

FCF 10: GBP 16M

FCF Yield: 28.5%

P/Tangible Book: 0.69x

Assuming break even in 2H10, the aviation business currently trades at 0.56x EBITDA despite being historically profitable and cash generative. This is simply far too cheap.

In addition to valuation, there is a very big intangible: Philip Meeson, the Chairman and CEO.  He owns 40% of the company and has been involved since 1983 when his investment vehicle first purchased three predecessor vehicles to this company known as the "Channel Express" companies.  The majority of his net worth is tied up in Dart Group stock, which trades at one third of its peak level in 2007, when they were making less money and had a net debt position; the credit crisis and overexpansion in FY 2008 seem to have made him somewhat more cautios in the pace of expansion and with demand down in FY 2009, he took capacity down by over 20% in order to preserve profitability.  In addition to his financial acumen, he has a winning manager's drive: those who know him say the first thing he does when he wakes up Sunday morning is check out Saturday's bookings and he has been detained by police at the airport for yelling at his own employees because customers were being kept waiting.  While we would love to see him in a better business than passenger air travel, we get to buy in alongside him at an incredibly cheap valuation.

Ultimately, we think the fact that just one analyst covers the stock and management is reluctant to talk to investors makes people uncomfortable, in addition to the fact that they own an airline in the UK that focuses on leisure travel.  But my view is that all of those risks are more than discounted by cash, a profitable distribution business and a manager who has spent the last 27 years building this company up from nothing to yield an extraordinary deep value opportunity

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