Signature Aviation's take-off looks premature

The shares have rallied over 70 per cent since their March lows. But this momentum seems optimistic considering the crisis facing the aviation industry and recent analyst downgrades (see chart below).

Covid-19 disruption saw Signature’s flight activity plunge by 77 per cent year on year in April, with revenue from continuing operations declining by almost a quarter at constant currencies across the first four months of the year. In response, the group has cancelled its 10.57¢ final dividend, negotiated rent relief and aims to halve its 2020 capital expenditure from previous guidance of $100m-$110m. Helpfully, three-quarters of its cost base is variable, with the largest expense of fuel flexing with volumes while direct labour has been reduced by over 50 per cent.

While demand for business jets may increase in a post-Covid-19 world as (wealthier) people and companies look to avoid crowds, we feel a more likely scenario is for demand to remain depressed. With the proliferation of remote communication tools, some corporations are likely to substitute discretionary travel with cheaper technology. Reflecting the uncertain outlook, it’s worth noting that the group’s largest customer, Berkshire Hathaway’s (US:BRK.A) NetJets, has deferred and cancelled aircraft deliveries due this year.

Concerns are exacerbated by gearing. Even excluding $1.2bn of lease liabilities, net debt was just over $1bn as at 31 December, equivalent to 2.2 times cash profits (Ebitda). Peel Hunt expects this "leverage" multiple, based on figures used to calculate debt covenants, to  hit 4 times this year which is only just below the covenant on Signature’s $400m revolving credit facility (RCF) of 4.25 times. The sale of the ERO business could ease the pressure, but the business has been held for sale since 2018 and its net asset value was written down from $261m to $178m last year.