Investors know that transport stocks can be a good way to play fundamental macroeconomic trends; North American railroads like Union Pacific (NYSE:UNP), for instance, have done quite well since the United States economy started to pull out of the recession. Likewise, the recent malaise in the global economy (particularly Europe and China) has done no great favors for international cargo carriers like UPS (NYSE:UPS) and FedEx (NYSE:FDX). Air cargo has definitely stagnated of late. While conditions haven't seen the crisis levels that some seaborne shippers have seen, companies like Hong Kong Airlines and Cathay Pacific have seen significant declines in cargo volumes and have been cutting back on capacity. This is bad news for air cargo players like Atlas Air (Nasdaq:AAWW) and Air Transport Services Group (Nasdaq:ATSG) as well, but the question remains whether this market will rebound later this year. While I recently highlighted Atlas Air as a worthwhile stock to consider as a late 2012 rebound play, more aggressive investors may also want to consider Air Transport Services.
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It's been a Tough Year so Far
This hasn't been an easy year for Air Transport Services, as the company has had to digest the loss of a major customer and delays from many others. In the second quarter, for instance, reported revenue fell nearly 40% on a year-to-year basis, and mainly due to a nearly 26% drop in ACMI revenue. Air Transport Services saw its ACMI block hours decrease 15%, due in large part to the loss of Schenker as a customer. If there was good news, though, it was in the sequential improvement in ACMI performance and the 15% increase in ex-Schenker block hours. That said, it's not just about revenue. While cost controls kept the decline in operating income limited to about 5% and adjusted EBITDA fell about 8%, management cut its EBITDA guidance by 10% (the second straight cut in guidance). Management is taking steps to restructure in the wake of losing Schenker's business, including merging the two subsidiaries that served the customer, but many customers have dragged out the start date of lease agreements - forcing the company to foot the bill longer than anticipated.
SEE: Zooming In On Net Operating Income
Still Some Reasons for Hope
I don't believe that Air Transport Services is a lost cause. For starters, the company's relationship with DHL (a part of Deutsche Post) seems solid and revenue here is growing at a double-digit clip. What's more, Air Transport Services seems to be picking up incremental business from DHL - business that came about when the company decided to stop using a rival's older, less efficient aircraft. Frankly, I expect this to be an industry-wide trend - tougher times are going to force marginal competitors out to the fringes (or out of business altogether), and give Atlas and Air Transport Services a chance to fill the gap.
SEE: How Inflation Has Affected Transportation Prices
Air Transport Services recently secured a two-year agreement with the government that makes it the exclusive combi services provider to the U.S. military. In addition, companies like Apple (Nasdaq:AAPL) and Nike (NYSE:NKE) are increasingly turning to air cargo for their shipment needs, and this seems like the new normal for high-ASP products sourced out of Asia. It's also worth noting that Air Transport Services has, at least by the standards of this industry, a pretty clean balance sheet and a modern fleet. While business conditions have forced the company to delay an additional 767 rollouts, both Atlas Air and Air Transport Services should benefit by offering more modern, cost-effective fleets to cargo customers.
SEE: Dead Airlines And What Killed Them
The Bottom Line
Readers should not fool themselves into thinking that Air Transport Services is a safe stock or that a late 2012 cargo traffic rebound is in the bag. The company still has a high reliance on a relatively small number of customers and further deterioration in global air cargo traffic could really whack forward EBITDA estimates. On the other hand, a lot of these risks are known and the market has already marked these shares down. Even if Air Transport Services should trade at a 25% discount to Atlas Air, a four times multiple on current 2013 EBITDA estimates suggests a fair value above $7 for the stock. While FedEx, UPS and Atlas Air are all likely safer bets on an air cargo recovery, investors who really want to gamble on a rebound should consider the shares of Air Transport Services.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.