The flight support company is looking for acquisitions.
In a cyclical sector, shrewd businesses invest in the downturns to reap the rewards when volumes recover. BBA Aviation (LSE: BBA) believes its markets have turned the corner, and has raised an £89m war chest in a share placing, spending half of it immediately on two acquisitions.
The company is a leading provider of support and aftermarket services to the aviation industry. Over three quarters of revenues come from North America, with two thirds derived from business aviation, a further 30% from commercial airlines and 5% from the military.
Business and commercial flying hours drive BBA's business, and in turn they are heavily dependent on the state of the US economy. 70% of the world's business jets are in North America where they provide fast, convenient and price competitive alternatives to commercial flights. Chartered business jets break even with commercial flights for parties of around 7 passengers.
Flight support
Operating under the Signature and ASIG brand names, BBA's flight support division contributes 60% of profits.
Signature is the world's largest provider of refuelling and ground support services for business aviation, an activity known as fixed base operation (FBO) in the US. The term comes from the introduction of legislation in 1926 which forced the previously transient operators to establish permanent bases.
Signature operates in over 100 locations of which over half are in North America, including 30 in the top 50 US metropolitan areas.
ASIG offers similar services to the commercial airline industry, and is the largest independent refueller with operations at 70 airports worldwide, including 37 of the top 100.
Aftermarket
The other 40% of profits come from the aftermarket division, which provides overhaul and repair of jet engines to the business and general aviation market. It also serves legacy markets: the ageing engines and systems which original equipment manufacturers are reluctant to support.
BBA spent £38m of its fund raising by purchasing GE Aviation's legacy fuel measurement business. The business assembles and overhauls the fuel gauge systems of commercial and defence OEMs, including planes such as the Airbus 319/320, Boeing B777 and Eurofighter Typhoon. With operations in the UK, US and Singapore it extends BBA's reach into commercial aircraft, and enlarges the geographic footprint outside the US.
A further £7m has been spent acquiring an FBO in Montana. Together the placing and acquisitions are marginally dilutive, with the legacy systems acquisition planned to reach BBA's target 12% ROC within three years.
Growth
On a constant currency basis, revenues grew by 5% in 2010 to £1.2bn, as the flight support division benefited from a recovery in US business flying hours.
The aftermarket cycle lags the support market and turned up in the second half of 2010, but overall was flat. Both segments stand to benefit from continued recovery in the US economy and the corporate sector in particular -- and are similarly vulnerable to any weakness.
Growth is also expected to come from:
- consolidation in the fragmented FBO market, where Signature has as many locations as the next two operators combined;
- geographic expansion into high growth markets, including emerging economies;
- new engine authorisations to expand the scope of aftermarket services; and
- increased OEM outsourcing and consolidation opportunities in the legacy systems market, such as the GE Avionics acquisition.
BBA has good economic moats. In the FBO business, its market leading network gives it an advantage over smaller operators. In the aftermarket business, authorisations and intellectual property in the highly regulated market for aero engine/parts servicing are barriers to entry.
Balance sheet
The placing enables the company to expand by acquisition without putting further strain on its balance sheet.
Net debt had historically been a problem, but by December 2010 net gearing was down to 65% (against 87% in 2009 and 127% in 2008) with interest covered 6.5 times. The company generates cash -- cash conversion was 124% -- and the financial risk doesn't seem too high.
Further comfort comes from BBA's low operational gearing, meaning that a relatively high proportion of costs are variable. So its earnings will not ratchet up post recession as fast as we've seen with, say, the highly operationally geared engineering sector, but in downturns it is less likely to be plunged into losses.
That is amply demonstrated by its track record over the past five years.
| | 2006 | 2007 | 2008 | 2009 | 2010 |
|---|
| Revenues (£m) | 950 | 979 | 1,156 | 1,081 | 1,183 |
| Profit before tax (£m) | 70 | 111 | 84 | 60 | 85 |
| Margin | 7.4% | 11.3% | 7.3% | 5.6% | 7.2% |
What you don't get with BBA, though, is tangible asset cover. The £580m of intangible assets are £100m greater than net assets.
Valuation
After a 7% increase in 2010, the dividend yields 3.8% (at 211p per share), with dividend cover maintained at around two times. With a P/E of 12 the shares are reasonable, and offer an interesting play on the US economy with decent prospects of long term growth.
More from Tony Reading:
> Tony Reading has shares in BBA.
