Is $AIRT cheap enough to offset corporate governance flags?

A long, long time ago, I mentioned AIRT, a profitable company trading for less than book. Since that time, the stock price has gone down >10% (from the low $9s to the low $8s) despite a 7% increase in revenue and ~4% increase in book value. So I thought it was time to take another look at the company in advance of tomorrow’s (November 2nd, 2012) earnings release.

Basically, what I found was a company that I think contains a very good deal of value that is being hidden by poor corporate governance and overcompensated management. However, there’s reason to think that might change.

So let’s start with the basics. AIRT operates in there divisions: Air Cargo, Ground Equipment, and Global Ground Support. What’s really attractive about AIRT is not just that the company as a whole has posted an operating profit every year I can find a 10-K for (the earliest 10-K I can find is the 1996, which include 1994 results. Thus, an almost 20 year record of profitability!). What’s really attractive is that the ground equipment division’s operating loss in 2012 was the first time one of the company’s three current divisions had posted an operating loss since 2002!

So what do the three segments do?

Air Cargo (~55% of revs) serves as a “feeder” for Fedex. Basically, Fedex gives them planes and pays for all of the operating costs, plus a management fee, and AIRT makes sure the planes get to where Fedex needs them.

Then there’s the ground equipment division (~35% of revs), which makes ground support equipment aimed at de-icing. You can find a picture of their biggest piece of equipment here.

Historically, much of this segment’s revenues have come from contracts to provide mobile deicers and tow trucks to the Air Force. While revenues from these contracts have been slightly lumpy (falling to basically nothing in fiscal 2011), the company has been supplying them for a long time and there’s no reason to expect this revenue to go away any time soon.

Finally, there’s the ground support division (~10% of revs), which provides ground support and airport facility maintenance to airlines. Historically, the bulk of this divisions revenue came from Delta. However, in late 2010, Delta modified the agreement with AIRT, which significantly cut into this segment’s revenues and earnings. However, the Support division has been growing since the Delta cuts by finding new customers.

Even at a glance, the stock looks relatively undervalued. TTM EBIT comes in at ~$2.5m, versus an EV of ~$17.8m for an EV / EBIT of 7.2x. This is actually on the very, very low side of earnings power for AIRT- it’s the lowest earnings have been since FY 2003. The decrease is completely attributable to record low consolidated margins (TTM EBIT margins come in at ~2.5%; from 2004-2011 they never had a year below 4% and their median margin was 5.9%), which in turn is 100% attributable to the operating loss caused by their ground equipment division due to lower sales.

I think that’s a big part of the opportunity here though- in their most recent quarter, the ground equipment division turned to an operating profit as revenue in the division due to a 150% increase in sales. If the Ground equipment division earned $1m in operating profit this year (the pace they are on, which would be well below both their historical earnings rate and their historical margin given their revenue pace) and the other divisions net out flat year over year (the pace they are basically on), that would give us EBIT this year of $3m+ and put the EV / EBIT multiple below 6x. Average EBIT for the past ten years (including 2003, which seems like a very low outlier if you go back and look at it) come in at $3.7m and $4.5m for the past 5, so that $3m is probably understating the earnings power of this business.

In addition to looking cheap on an earnings basis, the stock looks cheap on a book value basis. I have NCAV at $9.30+ per share and book value at $10.90+ per share… both well in excess of today’s share price of ~$8.30. Historically, this is a company that can generate 30%+ pre-tax ROIC. Stocks w/ that type of ROIC generally trade for a premium to book value.

But there’s reason to believe that both ROIC and the earnings power of the business are actually understated.

Why?

Basically, I think management is way overpaying themselves. The top 3 officers each make a base salary plus have a provision that gives them a bonus equal to (in total) 5.5% of pretax earnings every year. All told, the “corporate” segment is consistently eating up 35-45% of AIRT’s operating income before corporate allocation, with most of that coming from just the top 3 officers salaries.

That’s absolutely insane. But it also represents an opportunity. An acquirer could purchase them and quickly strip those costs out, resulting in significant synergies.

Alternatively, an activist could come in and force management to “rationalize” their salaries, which would result in a huge boost to the bottom line for shareholders.

That’s what I think is most likely here. Two activists have bought up just under 20% of AIRT’s shares and have already won a board seat. (Incidentally, Nick Swenson, the activist who won a board seat, just filed a 13-G on Solitron…). Management seems to be worried, as they released a poison pill preventing anyone from acquiring more than 15% of shares outstanding.

They probably should be worried too. Given their excess compensation and that they own barely more than 6% of shares outstanding, they’d likely be outvoted in any proxy fight.

Are there risks here?

Yes, of course.

The biggest one is the loss of their fedex contract. Fedex accounts for more than 50% of revenue, and their contract expired in October. Hoever, I’d guess there’s a really strong chance that it gets renewed. For one, they’ve been working with Fedex for decades and are their largest feeder. Seconded, their most recent 10-Q indicates they’ve been gearing up for more planes, not less.

But even if Fedex drops Airt, I think the great thing about an investment at these prices is you likely won’t do to poorly. This is a company trading below NCAV. If they lost the Fedex contract, all of the A/R associated would wind down, which would provide the company w/ a bunch of excess capital and two historically profitable segments. In other words, while it might not turn out to be a home run in that scenario, there’s plenty of downside protection.

The other risk is the activist fail. I don’t think this is a huge risk, as if the activists can’t do anything, things would basically stay at status quo and the company would still look undervalued to me.

Disclosure- Long AIRT and SODI

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