Q1 2020
Q1 2020 Earnings Season
Medley
08/05/2020
Introduction
We’re in earnings season so I thought it would be a good idea to do an update on some of the companies that I wrote about before.
Aercap
Aercap results came out this week. They were better than I expected.
Earnings-per-share (EPS) were $2,14 for the quarter, which on a $28 stock represents a Price-to-Earnings (PE) of 3.3. In case you haven’t noticed, this is CHEAP! It is true that a good chunk of this profit won’t be paid right away due to the deferrals the company is entering into with its customers, but that doesn’t matter. Aercap has entered into aproximatelly $300M of rental deferrals and expects to enter into another $300M for a grand total of $600M. The amount deferred is usually equivalent to 2 or 3 months of rent and the repayment usually starts 4 to 6 months later.
There were two major fears surrounding Aercap’s business going into this crisis. The fear of default by a large percentage of its clients and the fear of impairment charges that could lead to a equity wipeout. I wrote about it HERE. Interestingly enough there were no significant impairment charges in the first quarter and the book-value has gone up to $73,69 (which is where the stock should be trading for).
Now the second fear. Approximately 70% of Aercap’s fleet is leased to flag carriers for Chinese and US “majors”. This means that the company can be “relatively” sure of the continuation of payments on those leases. Most of these airlines are getting help from governments so the risk of default is minimal. When a company enters Chapter 11 or Administration, which are different stages of the bankruptcy process, it usually has 30 to 60 days of protection from its creditors (aka Aercap). After that, it either pays for the lease or returns the aircraft. After coming out of these restructurings, many companies maintain the majority of their fleets. Gus (Aercap’s CEO) believes this is what will happen with Virgin Australia. In case you didn’t notice it, Sir Richard Branson is giving its famous private island as collateral for a loan. Then there’s the Norwegian debt-to-equity swap. Aercap is now a shareholder of Norwegian. It accepted to exchange what it was owed for a piece of the company. This is not frequent and we shouldn’t expect to be seeing more of these deals.
Aercap has also deferred over 60 aircraft deliveries in order to lower the Capital Expenditures (CAPEX) for the year. It’s not as if Boeing or Airbus are spitting out new aircrafts every day in this environment. Quite the opposite, in fact. The company expects the Capital Expenditures for the remainder of the year to be $1,3B (already fully financed). This is WAY down from the $3,9B it expected to pay when I wrote my last piece on Aercap. And this is great for Aercap investors. Not so much for Boeing or Airbus investors.
Back in March, Aercap decided to drawdown on its “Revolving Credit Facility”. This means that the banks had agreed to a certain level of debt, the company wasn’t using all of that debt and it decided that it would now use it, so it “draw it down”. This spooked many investors into thinking that the company was in some sort of financial trouble. It wasn’t. This was a precautionary measure. So much so that they have already repaid $3B of those $4B. The company now has $11B in liquidity, which is twice its cash needs over the next 12 months. Said in another way, it has $5,5B of excess cash coverage.
I’ve heard some famous investors say that there are just too many aircrafts in the world. That might be true BUT, only 12% of all the aircrafts in the world are New Technology. And guess what? 59% of Aercap’s fleet is New Technology. Besides, I think that when this is all over, airlines will prefer to lease airplanes rather than owning them. And who will they lease those airplanes from? Exactly.
The company paused its share repurchase program because it’s highly dependent on the rating given by the rating agencies. You see, if it keeps its Investment Grade rating the company will continue to be able to borrow money at low prices. Needless to say that this is a major factor in Aercap’s success. This is what the company does. It borrows money on one side and lends it (in the form of aircrafts) on the other side (it’s essentially a bank). Airlines are known for having poor credit ratings and that’s why they pay the lessors. They get to spend less than what they would if they paid the banks instead. Now, if Aercap sees its cost of money increase, it will have to charge its clients more, reducing the cost advantage, which isn’t good. All of this to say that the ratings depend on a great part on the soundness of the balance sheet and in order to preserve cash the company decided to halt the share repurchase program. That’s a pity. That also tells me that the management team is preparing for even worst times.
There are many other nuggets in the company’s PRESENTATION and in the Earnings Call. If you’re interested in knowing more about the aircraft industry, I strongly recommend you to read both of them.
The bottom line is that the investment thesis is playing out as expected and Aercap should come out of this crisis in an even stronger position after many of its rivals disappear.
“In the Chinese market we are getting paid now again the regular rate on rental. Those granted deferrals in February and March primarily in China, they are back on track at the moment.” Aengus Kelly, Aercap CEO
Facebook is still chugging along. Revenue was up 18% while the operating margin went down by -11% due to the increased spend in R&D, particularly in AR/VR. I’d love to know what these guys are up to. Free-Cash-Flow (FCF) reached record levels of $7,3B on Q1. The market was expecting a bloodbath – especially for Q2 – but Mark Zuckerberg put some ice on the burn by saying that for the first weeks of April revenues were flat compared to last year.
Facebook also bought a stake in the Indian telecommunications company Jiro. I’m still not fully aware of all its implications, but India being Whatsapp’s largest market and Jiro being India’s largest low-cost mobile phone seller, I think this is a great match. Not to mention the endeavours Jiro is making with local businesses regarding payments and online orders. All in all, Mark seems to be one step ahead of Jeff Bezos (Amazon) on this one.
The only thing I’m not liking is the competition stepping on Facebook’s toes. As a Facebook shareholder I hate it when people talk about Zoom (and Houseparty to a lower extent). How could Facebook let it get to where it is today? I know that Mark likes to thoroughly test everything before launch but he lost a great opportunity to introduce Rooms earlier. I’m eager for Facebook to release payments across its platforms as soon as possible.
“we have seen signs of stability in the first three weeks of April, where advertising revenue has been approximately flat compared to the same period a year ago.” Mark Zuckerberg, Facebook’s CEO
By the way, you can now order food from Insta Stories. Bye bye Grubhub and Uber Eats?
One last thing. Facebook is creating something like an Internet Court. At some point, Facebook will be able to claim that the responsibility for content control is in the hands of this Court and by creating it in the first place it will be able to influence its rules and prepare itself right from the start. Will this “Court” work? I don’t know, but Mark is doing it and he has been 10 years ahead of everyone else so I guess he knows what he is doing.
Riwi
Riwi is one of those companies that I wish I had included in the portfolio a month ago when it was trading for less than half of today’s price. This is a fascinating company. The only thing Riwi needs is sales. There are no Capital Expenditures (CAPEX), it doesn’t need a new factory, it doesn’t need to open more stores. Right now, it needs to land more clients! Preferably recurring ones. And that’s what it’s doing. There is a new Chief Revenue Officer in place whose sole task is to increase revenue and the company is hiring new sales representatives. They will only accept new contracts that offer a reasonable assurance of being renewed 5 more times.
So far Riwi’s margins have been kind of unpredictable due to the lumpiness of revenue and because this is still a young company. The highest net margin it has achieved was 54%, which is bonkers. And all of this while employing little to no capital. If we annualize the profit of $500K it got in the first quarter we get to profit for the whole year of $2 million. The capital that’s invested in the business is $1,1 million. This would mean a Return-on-Invested-Capital of 182%!!!
The company has added $2,5 million in recurring revenue from the beginning of the year and Neil (the CEO) is aiming for $30M in 2024! The company is worth $81 million today. If it gets those $2 million in profit this year, it would mean a Price-to-Earnings ratio of 40. A bit too lofty for traditional valuation standards. There are several ways one could look at Riwi. Here’s one: If an investor is looking to get a 15% return on his or her money, the company would have to reach $14 million in revenue in 2024 (5 years from now). That would represent a year-on-year growth rate of 35%. And the management is aiming for more than double that amount, so…
I want Riwi to be a part of the All in Stocks Portfolio, but I am currently suffering from Anchoring Bias. I’m looking at the price it was selling for just a month ago and I find it hard to pay twice or three times that amount. I know. Where the share price has been before shouldn’t matter. I’m going to think about it during the weekend and I’ll let you know when I make a decision.
Altria
On my previous take on Altria entitled “Altria is just too cheap” I made the case for a price re-rating based on the high dividend yield (+8%) in a world where interest rates are at all times lows to more “normal” levels of around 6% which would factor in the “risk” of declining number of smokers. The stock was then at $41 and I made the case for it to go up to $55. The stock is now under $36 and the dividend yield is 9,6%.
The thing is, my girlfriend, who unfortunately is still a smoker (she smokes Heets, which isn’t so bad) is confined at home and she hasn’t quit smoking. In fact, I would say she’s smoking even more than before. The fact that she isn’t at her workplace let’s her smoke whenever she wants. And like her, I’ll bet you there are millions.
Altria’s chief capital allocation policy is to keep paying 80% of its profits in dividends. It’s a mature business, so that could be called a wise decision. At these prices, I would prefer share repurchases but who am I to mess around with the dividends. For a company like Altria, cutting the dividend would be a sacrilege.
Although the company isn’t in any way near bankruptcy, it’s in times like these that the optionality allowed by a low debt level is the most important. To preserve liquidity the company has stopped its share repurchase program, exactly when it should be going on a buying spree. If it wasn’t paying $1,3B annually in interests, it would now be able to add huge value to its shareholders.
Recently Howard Wilson, the former CEO got Coronavirus and he was replaced by the CFO. The company also decided to separate the roles of Chairman of the Board and the CEO, which they should’ve done years ago.
Our dividend is important to our investors and remains a top priority for us. Altria Q1 2020 Press Release
My biggest fear regarding Altria was that they couldn’t reopen the Richmond factory for some time, but the factory is up and running again. The company reported a 6% growth in cigarette shipments, (going against the secular trend) which together with higher prices led to a 16% growth in revenue. The company says that this growth in cigarette shipping was due to several factors, one of them was the consumer pantry loading in anticipation to the COVID-19 lockdown. If we dismiss these factors, cigarette shipments would’ve been down by 3,5%.
Let’s say that things turn really sour and we see a similar decline in cigarette shipments to what we saw back in 2009 (-12%). In that scenario, we would be talking about $22,6B in revenue and $5,7B in net income. That means that the company would now be trading at a forward Price-to-Earnings ratio of 12 but the dividend would have to be cut. And that would lead to a major blow to Altria’s stock price. I was planning on adding Altria to the All in Stocks Portfolio if it came under $35, but I am increasingly wary of the potential downside of this crisis. I know this might come as a turnoff to some of you, but my first goal, before thinking about the upside, is limiting the chances of capital loss. I will keep following Altria closely.
MTY Food Group
MTY Food Group is a company that I like. Its only problem right now is being a franchisor of Quick-Service-Restaurants. I was looking for the Earnings Call Transcript on Twitter and surprisingly, it was a subscriber, Diogo Gonçalves, who kindly sent it to me. Thank you! Financial releases are and will remain highly important to investors but it’s in the Earnings Calls that the management shares precious nuggets that investors can’t find elsewhere.
In the first quarter of the year – which runs from November 30 to February 29 – System Sales (total sales from all of the restaurants) were up 45% (due to the Papa Murphy’s acquisition) but then they were back down 9% in March. Excluding the impact of the newly acquired brands, the decrease for March would’ve been 39%, which came as no surprise. The company had Same-Store-Sales (SSS) growth of +2,1%, which is great. This SSS figure excludes the PaPa Murphy’s (PM) restaurants because PM was acquired recently. Papa Murphy’s SSS growth was negative, which is not great, but investors are used to it. Revenue was up 40%, EBITDA was up 45%, FCF was up 23%, all great results. The problem came after the first quarter and that’s what matters most right now.
The company stated that “sales seem to have reached a bottom around the second week of April and have started to slowly go back up“. Of the total number of 7.300 restaurants, 2.200 are still closed. The company has allowed its franchisees to defer on the royalty payments for 4 weeks and then for an added period of 4 weeks. It has also offered its franchisees the option to pay the deferred amounts early, in exchange for a 40% abatement on the royalties owed. Over half of the network has chosen to pay early. The company is currently in negotiations with its franchisees, landlords, bankers and suppliers and it says that these negotiations are going well.
They are breaking one of their debt covenants, the Debt-to-Ebitda ratio, which I was already expecting but I don’t think this is serious because its lenders know what a great business MTY is. (EBITDA stands for Earnings Before Interest, Tax, Depreciation and Amortization). On my Zero Revenue Liquidity Test, I’ve assumed that the company would be burning around $5,2M per week, or $62,5M per quarter. The company said that it now expects to burn $10M in cash in the second quarter and hoped to be FCF neutral in the third quarter. That’s much better than what I had envisioned. I take my hat off to this management team.
Wrapping up, I think the company is on the right track, thinks are looking better than what I had envisioned but I still feel it’s too early to get the whole picture. MTY is clearly not going anywhere, the questions now are 1) for how long this confinement will last, 2) will there be any more confinements in the future and 3) how many franchisees will come out of this alive. Until I get a clearer picture of the downside, I can’t be seduced by the upside.
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