Travel is again the prey of Covid-19, with people wondering if they should abandon their plans to ski travel to Canada for Peloton workouts at home. Flying under the radar is a small-cap aviation stock that could be poised to explode, especially if the Omicron variant becomes a threat next year.
Investors in transport and fortress infrastructure
(ticker: FTAI) is a major player in the rental of aircraft engines to passenger and freight carriers. Structured as a limited partnership, or LP, it also owns infrastructure assets including railways, an energy terminal and a power plant.
More than two-thirds of Fortress’s revenue comes from aviation, which needless to say is under pressure. But sales are expected to jump 74%, from $ 492 million in 2021 to $ 857 million next year, according to Wall Street estimates. Profits are estimated at $ 1.44 per share in 2022, down from a loss of 91 cents this year. The stock, which pays an annual dividend of $ 1.32, returns 5.0% at a recent price of $ 26. It is trading at 18 times the profits.
What makes it really intriguing, however, is a catalyst that has worked wonders for other limited partnerships: Fortress plans to convert to a corporate structure. And it is divided into two shares negotiated separately, one for aviation, the other for infrastructure.
“A pure aviation story will be easier to understand than a story with four infrastructure assets,” said Fortress CEO Joe Adams. Barron. “We think we will reach investors who won’t buy the stock now because they don’t understand or don’t know the other sector.”
|Recent price:||$ 26.23|
|Current year change:||12.5%|
|Market value (bil):||$ 2.6|
|2022E sales (in millions):||$ 857|
|Net income 2022E (in millions):||$ 148|
|RPA 2022E:||$ 1.44|
E = estimate
Pending regulatory approval, expected in January or February, the $ 2.6 billion company will split into separate aviation and infrastructure companies. The conversion will eliminate the need to file K-1s, complex tax forms that prevent many hedge funds and mutual funds from directly holding LPs. Index funds that are not eligible to hold limited partnership units may also purchase shares of the companies, thereby broadening the investor base.
The conversion playbook was a hit in private equity, where several companies made the switch in 2018 and 2019. Private equity stocks gained an average of 22% in the 12 months following a conversion, compared to a return of 4 % for the S&P 500 Index. Some Energy Masters limited partnerships have also experienced a rise in stock prices after moving to a corporate structure.
Fortress rents 450 engines, including equipment on 120 aircraft it owns. Two-thirds of its engines are the workhorse of the industry: a narrow-body model known as the CFM56, with 22,000 trade units in circulation around the world. Fortress buys used engines, overhauls them, and then leases them to passenger or freight carriers; around half of its business comes from European airlines, with the rest scattered around the world.
Airlines often turn to rental because it cuts down on capital expenditure. This is especially crucial now that many carriers are flying on shoestring budgets, with trips deeply depressed. Fortress recently made deals with Avianca and ITA Airways, for example, buying 35 planes from carriers and re-leasing them.
Lease periods are on average 18 months for engines and 36 months for airplanes, followed by a necessary overhaul before an engine can be returned to service. Rates are typically $ 60,000 per month, plus maintenance. About 74% of Fortress’s autonomous engines are in service. Rental rates increase and terms are extended as flight time increases. There is also a shortage of aftermarket engines due to the postponement of overhauls by airlines to save capital.
The aviation industry is expected to be more profitable as Fortress vertically integrates parts and maintenance services. The company has a new joint venture with parts maker Chromalloy to build five critical spare parts for CFM56 engines (four are awaiting regulatory approval). Fortress may purchase these parts at cost from Chromalloy and receive reduced sales to other airlines. Fortress also entered into a new maintenance services contract with
(LMT), and it works with
(AIR) to repair and resell parts.
The partnerships are expected to make Fortress the cheapest CFM56 engine operator in the industry, says Giuliano Bologna, analyst at Compass Point. “They are the only ones who can source parts at cost,” he says. “It’s a significant improvement and a return they can earn. Fortress expects to save $ 3 million on an average engine overhaul of $ 6 million, giving it more money to reinvest, finance equipment, or pay dividends.
Parts and service offerings are also expected to increase operating profit. The company expects its aviation segment to generate $ 550 million to $ 600 million in profit before interest, taxes, depreciation and amortization, or Ebitda, next year, up from an estimated $ 370 million in 2021.
Fortress’s infrastructure assets are also expected to start generating positive cash flow, after years of development and acquisition costs. Its Ohio power plant recently began operating with an average of 8.5 years of contracted electricity at fixed prices. For its power terminal in Texas, Fortress signed a 10-year contract with
(XOM) last summer, from 2023. It also has two other projects: a railroad for transporting steel in Indiana and Pittsburgh, acquired from
(X) this year, and a 1,600 acre site in New Jersey that it is developing as a liquefied natural gas storage and export / import hub.
What is all this worth? Bologna hits $ 41 in combined net worth after the split, the aviation title is worth $ 32, and infrastructure is $ 9. It values the two parties at nine times the 2023 EBITDA of $ 821 million, three quarters of which in aviation. “There is an execution risk to the story,” he says, “but if you peel the onion the complexity will be greatly reduced and it will open up the stock to more investors on either side.”
Some hedge funds see value in the stock. Jacob Rubin, portfolio manager at Philosophy Capital, expects stocks to hit $ 40 to $ 50 by the end of 2022, eventually reaching $ 80 in a “bullish scenario.” One problem would be regulatory delays in approving more aviation parts, he notes. Still, says Rubin, even if the stock hits $ 40, “that would be a tremendous return.”
Brian Smoluch, co-manager of
Hood River Small Cap Growth
fund, owns 3.2 million Fortress shares through his company. “There are a lot of ways to explain why this thing is cheap,” he says. “He’s just waiting for a catalyst.
Write to Daren Fonda at [email protected]