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Why I’d avoid this FTSE 250 stock and what I’d buy instead

When I think of FTSE 250 aviation support provider BBA Aviation (LSE: BBA), I see a firm with high borrowings that has struggled to increase its dividend while serving a cyclical industry.

Perhaps because of those circumstances, the share price has been volatile. At around 303p as I write, it’s up more than 500% since its post-credit-crunch nadir around 50p in 2009. But the reversals along the way have been frightening. During 2015 the stock plunged around 34% before recovering the following year and making new highs the year after that. Then, in 2018 it dived by almost 40% and has been clawing its way back since.

Big disposal on the cards

My guess is that every time there is a cyclical lull in the economy or aviation industry, the share price goes into reverse. Or it plunges when investors anticipate a slowdown, whether it happens or not. Such is the predictive nature of the stock market, which looks ahead and tries to adjust for potentially falling company profits. And that effect can be most pronounced with cyclical enterprises such as BBA Aviation.

The firm provides a variety of services and support functions for Business & General Aviation (B&GA) including fuelling, ground handling, hangarage, aircraft maintenance, and amenities for passengers and pilots. I see danger in that set-up for investors because it would only take a decent economic slump to affect the airline industry and we could see BBA Aviation’s share price, profits and dividends plunging again.

And I think the company looks vulnerable because of its large debt load. But that situation could be about to change. It announced in today’s half-year report it has agreed to sell its Ontic business, which provides OEM-licensed parts for legacy aerospace platforms. The potential buyer is CVC Fund Vll, and BBA Aviation stands to make $1,365m from the deal.

Paying down debt and shareholder returns

The directors explained in the report they intend to use “some” of the disposal proceeds to reduce the firm’s financial indebtedness. They also plan to return “between $750m and $850m” to shareholders.

I think selling off part of the business is a good move because today’s figures reveal to us that net debt (on a Pre-IFRS 16 basis) rose by 7% compared to the equivalent period a year ago, to stand at $1,341m. That figure is around 6.3 times last year’s operating profit, which isn’t an immediate problem because the company can service its interest payments now, while the profits are rolling in. But if earnings collapse down the line, the move to reduce its borrowings could end up looking timely.

However, even after the disposal, BBA Aviation expects its net debt to be around 2.5 to 3 times EBITDA. And to me, it would make more sense to scrap the idea of throwing money at shareholders and use the cash to make the remaining enterprise as financially robust as possible. Especially since so many observers have been making noises about gathering clouds in the macro-economic outlook lately.

One of my basic rules for investing in individual company shares is that I must believe the stock can outperform the wider stock market before I buy. In this case, I think BBA Aviation’s cyclicality could bite investors down the line, so I’d rather invest in a FTSE 250 tracker fund.

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Kevin Godbold has no position in any share mentioned. The Motley Fool UK owns shares of and has recommended BBA Aviation. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.