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OPINION

Priced to gain altitude

Priced to gain altitude
August 25, 2016
Priced to gain altitude

Trading in the European market has been challenging and this has clearly spooked investors even though the board reported strong organic growth from its US operations in a trading statement last month. Gama operates 150 planes on behalf of their owners from 44 locations across five continents, providing a raft of services from aircraft management and charter through to engineering and support services

The US business accounted for 46 per cent of Gama’s proforma revenues of $413m last year and is expected to increase its share to over half of the total based on estimates from analyst John Cummins at brokerage WH Ireland. Though it’s faster growing, margins are lower so Mr Cummins expects the US segment (ground services and air operations) to contribute $8.3m of his group cash profit estimate of $22.4m in 2016, up from $7.4m of the group total of $20.9m in 2015. In the first half to end June 2016. Guidance from management is that group cash profits will be no less than €7.5m, down 9 per cent on the same stage last year, on revenues up 7 per cent to $205m.

The cautious economic outlook in Europe, coupled with political uncertainties, means that organic growth within Gama’s European operations will be at a premium. Given this outlook, analysts expect revenues from European air operations of around $120m for the full-year to account for just under a third of group revenue estimates, with a modest profit contribution of only $1.6m. But this is not the critical business in Europe, ground handling services is as this segment turned in cash profits of $14.4m on revenues of $45.3m in 2015. So, the key for hitting analysts’ full-year outcome will be how these ground handling services operations hold up.

Bearing this in mind, the group will benefit from a couple of acquisitions made this year: Aviation Beauport, a privately owned Jersey based business offering a range of business aviation services; and Flyertech, a privately owned Gatwick based businesses offering a full complement of airworthiness management services. Gama paid a combined initial consideration of £8.3m for the two businesses, a sensible price based on the £1.4m of cash profits they made in their last financial years. Those profits equates to 8.5 per cent of the £16.5m of combined profits Gama’s European air operations and ground handling businesses earned in 2015, so the acquisitions will make a significant contribution to this year’s outcome.

Overly bearish assumptions

The point being that even if the pressure on the European side of the business means that Gama is unable to deliver a $1.4m rise in group cash profits to $22.3m this year as analysts at brokerage WH Ireland predict, then it’s more than factored into the current valuation. That’s because in 2015 the $20.4m of group cash profits earned translated into $15.6m of pre-tax profits and EPS of 32 cents based on a 10 per cent tax charge. So after factoring in a likely cash profit contribution of $1m from the acquisitions of Beaufort and Flyertech this year, and $8.3m from the US operations, then this means that total profits from Gama’s European operations could fall by 10 per cent from $16.5m to $15m and it would still make the same profit as last year.

Moreover, the average sterling:US dollar exchange rate has fallen to £1:$1.403 in the first eight months this year, and will decline to £1:$1.372 if the current spot rate holds for the rest of the year. That’s more than 10 per cent below the average of £1:$1.529 for the 2015 financial year and means that even if Gama only reports flat profits this year then EPS of 32.5 cents are worth 23.6p, or 10 per cent more than they were last year. This means that with the shares priced at 165p, down from 220p when I rated them a hold for recovery in mid-June (‘Gama shares hit turbulence’, 14 Jun 2016), they are now priced on seven times these bearish earnings assumptions. There is also a 1.7 per cent dividend yield based on a maintained payout per share of 3.6 cents.

Of course there are risks. The fact that Gama’s share price has fallen by a quarter in the past 10 weeks indicates a fair degree of nervousness amongst investors especially as the business aircraft market is cyclical and spikes in economic uncertainty can subdue demand. That said, Gama provides support services for owning and operating an aircraft, so is less exposed to cyclical factors than the wider market.

The bottom line is that with the share price on the floor, and the rating so low, I feel that the risks are more than balanced by the potential for Gama to outperform my most bearish assumptions, and ones that not even city analysts are making. Reassuringly, the share price seems to have found a floor at the 150p level and looks poised to stage a rally from heavily oversold conditions. And that’s why I rate Gama’s shares a trading buy at 165p ahead of the first half results due out next month. My initial price target is 220p, and if that is surpassed the next technical resistance level is the 250p support level that gave way in late May.

On a bid-offer spread of 155p to 162p, I rate the shares a trading buy. Please note that the official spread is wider, but it’s possible to deal within the spread so please be disciplined.