Description

Dart Group plc (“Dart” or the “Company”) has been written up a number of times on VIC, most recently by mip14 in June of 2015. I have posted it previously as well (mid-2011). The basic profile of the investment case has been similar in each instance: i.e. the opportunity to buy i) a high return business, ii) with a solid balance sheet, iii) and a motivated, hugely invested (35%+ ownership) CEO iv) at a compelling valuation. Dart today trades at roughly 10x consensus EPS for the current fiscal year, or just 7x after excluding excess cash on the balance sheet.

The catalyst for this most recent opportunity has been Brexit. Dart is a UK-centric travel company, and the travel sector has been one of the biggest victims of the Brexit vote. Dart has been no exception, with shares falling by roughly a third since peaking earlier this year. Immediately following the Brexit vote, multiple European travel companies made negative guidance adjustments; however, in retrospect, it looks as if the majority of these companies simply used the Brexit vote as a convenient excuse to mask company-specific weakness that would have existed regardless of how the Brexit vote had turned out. The few U.K. economy-wide data points that have emerged since the vote have actually shown remarkably little negative impact from the vote although, admittedly, the true longer-term impact will take years to become clear as terms of Britain’s exit from the EU are negotiated and implemented. Notwithstanding these cross currents, for those investors looking for demonstrable company-level data, Dart has provided multiple updates since the Brexit vote supportive of the ongoing strength of its operations. Initially in July of 2016 (with release of the 2016 annual report), and again several days ago following the AGM, Dart management has stated that demand for its services remains strong, and is tracking largely in-line with its pre-Brexit expectations. These statements derisk the investment case materially.

Dart operates in two distinct segments: Leisure Travel and Distribution & Logistics. The Leisure Travel segment encompasses an airline (Jet2.com) that operates a fleet of 63 aircraft to holiday destinations throughout Europe and the Mediterranean. In addition, it includes a tour operator (Jet2holidays) that offers a wide range of inclusive vacation packages. The Distribution & Logistics business provides temperature-controlled distribution services for produce and other products to a wide range of retailers, processors, and growers through its owned warehouses and fleet of tractor trailers. The Leisure Travel segment accounts for the vast majority of the Company’s value, as it represents roughly 95% of consolidated operating income. Although the two businesses have a shared history, there is no compelling reason for them to continue to exist under the same corporate umbrella, and management has long maintained that they would be willing to part with the Distribution & Logistics business for the right price.

For a more detailed look at Dart’s businesses, I recommend that you read mip14’s June 2015 write-up. The Company’s annual report also provides decent detail and commentary (http://www.dartgroup.co.uk/report-and-accounts-2016/). For purposes of this write-up, I want to focus on just a few higher level trends that I think are relevant to both the business’s overall quality and the associated valuation implications. Prior to 2007, the Company’s Leisure Travel segment consisted solely of low-cost and charter airline operations. Management had historically demonstrated an ability to avoid the more extreme boom-bust cycles of commercial aviation, in part through a unique operating model that allowed it to keep utilization (and associated asset turns) relatively high. Notwithstanding this, from a public market perspective the business still suffered from the valuation taint that has long bedeviled the airline sector. In early 2007, Jet2holidays was launched. It has since grown extremely rapidly. Today, 40% of Dart’s airline seats (on Jet2.com) are sold to Jet2holidays packaged tour participants, and the operating income contribution from Jet2holidays is approaching that of Jet2.com. This is a major transformation with meaningful consequences. Effectively, as a fee-based business, the bulk of required asset investment is borne by the Company’s “partners” (i.e. hoteliers, rental car fleet operators, etc.). This leads to very healthy incremental margins and extremely high returns on invested capital. In practice, this has driven Dart’s consolidated returns on investment capital from the mid-teens just five years ago, to over 50% in the most recent fiscal year. Keep in mind, these consolidated returns are inclusive of both an airline and an asset-heavy distribution business, neither of which are generally viewed as implicitly high return in nature. Meanwhile, ownership of a captive airline provides the packaged holidays business with a range of competitive advantages, including pricing, scheduling flexibility, and better control over the entire customer holiday experience.

Dart Group’s founder and CEO is Philip Meeson. He owns 38% of outstanding shares. Although he is 68 years old, he is by all accounts absolutely obsessive about the business and, as such, I’m not banking on a sale of the business for value realization purposes in the near-to-medium term. Meeson can be difficult to reach, but other members of the management team are accessible.

In fiscal 2016 (ended Mar 2016) Dart Group delivered £0.60/shr in EPS. So, on face, at today’s price of £4.50 the shares trade at a sub-8x trailing P/E ratio. Consensus earnings for the current fiscal year (Mar 2017) are expected to come in at roughly £0.45/shr, implying a 10x P/E ratio. The bulk of the year-to-year decline is being driven by start-up expenses associated with two new aircraft bases the Company is establishing (on a current base of seven) in Birmingham and at London Stansted airport, respectively. These new aircraft bases should provide a strong foundation for continued growth going forward, and given management’s demonstrated history of strong incremental returns on invested capital I am comfortable with the near-term negative margin/EPS impact. As of Mar 2016 (date of last reported financials), Dart had excess net cash of roughly £1.30/shr (assuming 60% of total net cash is “excess”…this is in-line w/historical levels). So, net of excess cash, shares trade at 5x and 7x trailing and current year EPS, respectively.

In my experience, it isn’t often that you can buy a growing, unlevered business with 50% ROICs trading at a 7-10x EPS multiple (depending on how you choose to look at EPS). To boot, you have an incented founder/owner and clear visibility on the negative catalysts that have taken the stock down recently with clear indications that, at least in the near-term, market expectations are likely wrong. That is what the Dart Group opportunity is today.

Risks:

Of course, there are risks. Dart is undergoing a major fleet upgrade. This will eat into cash, and add some additional leverage to the balance sheet, over the next 12-18 months. The Birmingham and Stansted base openings could be ill-timed; perhaps management is expanding at exactly the wrong time. British pound weakness may turn out to be more of a demand headwind for international vacations (from the U.K.) than initial evidence indicates. Global travel is always subject to both irrational fears of, as well as true negative demand impacts from, things like terrorism, SARS/Zika/health scares, etc.

Catalyst

Business proves its ability to continue growing post-Brexit. Demand bump from new Birmingham and Stansted bases. Sale of Distribution business.