Description

Elevator Pitch:

KNFM is an Israeli aviation holding company consisting of four divisions.  Two divisions are very steady (military maintenance, airport services) and generated net income worth 22% of KNFM's market cap in an unsteady 2021.  Two divisions (aircraft leasing, airline) depend heavily on air travel and are currently worth 75% of KNFM's market cap.  The steady divisions limit downside while the other divisions provide 75% upside on recovering air travel.

This report will discuss:

1) The four company divisions

2) Outlook on the aviation sector

3) Valuation

4) Risks

1)  The four company divisions

1a) Maintenance Wings

KNFM owns 100% of Maintenance Wings, which provides maintenance services on Israeli Air Force aircraft.  There are two main projects.  The first is Lavie project, which is contracted through 2035 for 600M ILS revenue over 20 years.  Revenue is linked to a labor cost index and increases if the military requests additional work.  The Ministry of Defense can end the contract early if it no longer needs KNFM services, however, it's very unlikely to do so.  Proven aircraft models are often used for decades, military spending is very steady and the military selects and stays with contractors with good reputations and track records such as KNFM.  Cutting corners on maintenance is unlikely since cuts pose a risk to national defense.

Maintenance Wings' second project is for maintenance on transport aircraft.  The contract lasts through 5/2023 and was extended multiple times since starting in 2008.  Further extensions are likely.  Transport maintenance is 12% of Maintenance Wings' total revenue.  Losing the transport contract would be unfavorable, but manageable.

As Maintenance Wings works on military projects as opposed to civilian projects, the COVID pandemic had no impact and KNFM does not expect future disruptions.  KNFM does not break out capital expenditures by division, however net income has been steady at 11.3M ILS +/-6% over the past four years where KNFM separated Maintenance Wings net income from the rest of the company.

1b)  QAS - Quality Airport Services

KNFM holds 50% of QAS, which provides ground handling, airport lounge and catering services to various airlines and private aircraft in Ben Gurion International Airport.  Gurion is the main international airport and busiest in Israel.  QAS is contracted to manage services through the end of 2025 and its contract has been renewed multiple times.

Airport services usually exhibit steady growth as passenger traffic grew every year from 2009 - 2019 at 7.7% CAGR.  Traffic in 2020 and 2021 were 19% and 25% of 2019 traffic, respectively, due to COVID restrictions.  Recent traffic has steadily recovered, which I discuss more in section 2.  Net income attributable to QAS were 37.3M ILS (2019), 8.9M (2020) and 22.3M (2021).  COVID travel restrictions were most severe in 2019 with intermittent closures in 2021.

1c) Global Knafaim Leasing Ltd

This division leases passenger and cargo planes and is publicly traded as GKL.IT.  I reached 73M ILS for GKL's base case valuation using KNFM's 66% ownership of GKL and GKL's current market cap.  GKL is a mediocre business under ordinary circumstances and performed poorly during COVID.  Before 2019, more competitors entered the leasing industry while COVID restrictions severely reduced demand for planes.

Demand for planes has shifted to narrow-body aircraft with newer technology and better fuel economy.  GKL has been adjusting its fleet to meet demand.  The current fleet consists of eight aircraft: four narrow-body manufactured in 2015 or after, one narrow-body manufactured in 2005 and three wide-body planes, all 10 years or older.

Contracted revenue from existing leases is:

2022: 9.3M

2023: 7.0M

2024: 7.0M

2025: 6.6M

There's a sharp drop from 2022 to 2023.  However, in 12/2020, GKL had a sharper potential drop in contracted 2021 lease revenue and negotiated new contracts to maintain revenue.

1d) El Al Israel Airlines Ltd.

This division is publicly traded as ELAL.IT.  ELAL is a subpar company which struggled with profitability before COVID.  I reached 42M ILS for ELAL's base case valuation using KNFM's 6.6% ownership of ELAL and ELAL's current market cap.

2) Outlook on the aviation sector

According to the International Air Transport Association (IATA): "In 2021... [global] traveler numbers were 47% of 2019 levels. This is expected to improve to 83% in 2022, 94% in 2023, 103% in 2024 and 111% in 2025."  In addition to improved global air traffic conditions, Ben Gurion Airport traffic may improve as Israeli and foreign travelers were no longer required to take a PCR test upon arrival at Gurion as of 5/21/2022.  KNFM reported a strong recovery starting in 3/2022 and more recent reports support heavy air traffic in April.  Gurion air traffic also increased 388% year over year in May.  While uncertainty in COVID restrictions and economic conditions continue, current conditions imply a steady recovery.

3) Valuation

I give bear and base case valuations two years from now.

3a) Bear case

I assume continued intermittent COVID restrictions and/or a recession.  As in 2020-21, Maintenance Wings experiences no service disruptions since it's a military service provider, so net income is unchanged from 2021 at 10.9M ILS.  QAS net income is also the same as 2021 at 22.3M ILS (60% of 2019).  Global Knafaim Leasing and El Al Israel Airlines are worth 0 due to bankruptcy or divestment at low prices.  33.2M ILS total net income results in 4.6x p/e for two very steady businesses.

3b) Base case

Assume Maintenance Wings and QAS net income are the same as in the bear case.  Global Leasing and El Al Airlines reach break-even profitability on improved air traffic and maintain their current market cap of 73M + 42M = 115M ILS, or 75% of KNFM's market cap.  Assuming 4.6x p/e, KNFM can potentially gain 75% as investors become positive on Global Leasing and El Al Airlines.

4) Risks

4a) COVID travel restrictions

All divisions except for Maintenance Wings depend on air travel volume and are hurt by travel restrictions.  COVID restrictions are likely to continue to affect KNFM.  However, restrictions are likely to gradually loosen because Israel was among the first countries to receive the more effective mRNA vaccines and its healthcare system was quick to administer vaccines, lowering infection risk.  In addition, in 2021, the top 10 busiest countries with air travel to and from Ben Gurion Airport by number of passengers were the U.S., western Europe, Turkey, U.A.E. and Ukraine.  All countries have high vaccination rates except Ukraine, lowering the chance that travelers increase infection rates in Israel.

There's also a global shift towards increased risk tolerance towards pandemics as people become accustomed to living with COVID.  It's difficult to see a new pandemic from a COVID-19 variant or otherwise eliciting restrictions as severe as in 2019.

4b) Recession

In the event of a recession, all aviation stocks will drop, including KNFM.  KNFM has some downside protection from its current valuation and because Maintenance Wings and QAS are more recession resistant.

4c) Foreign exchange rates

In the past 10 years, the USD to ILS exchange rate varied from 3 to 4.  KNFM receives most of its revenue in USD, but costs are paid in ILS.  KNFM partially hedges against exchange rate risks.

Catalyst

Air traffic continues to show fast improvement.