Like most of the stocks I seem to have written about lately, fly-in fly-out airline Alliance Aviation Services Ltd (ASX: AQZ) is unloved by the market. The simple reason for this is that the mining boom is over and we don't need to drill for oil, gas, gold, iron, coal or copper anymore. Therefore, any company that makes any money out of resources is worth nothing.
Okay, so maybe I'm being a little facetious but it appears that this is close to how the market views these types of stocks today. For example, Alliance has a market capitalisation of around $55 million, net assets of $106 million and just announced an underlying profit of $13.2 million in the year to 30 June 2015, up from $10.9 million last year.
Unfortunately the story is a little more complex than that because the statutory result was a loss of $36.6 million. So, is Alliance profitable or isn't it?
The difference between the reported and underlying result is largely due to write downs on assets of $45.3 million. The reason for the impairment is that the financial outlook for the company has worsened and so its planes are worth less than what was stated on its balance sheet. There may be further write downs to come given sensitivity analysis by the company shows that a 3% to 5% fall in revenue would lead to further impairments.
Ultimately cash flows dictate the value of a business, and as an airline Alliance has to pay lots of money to maintain its fleet. Operating cash flows after capital expenditure were a paltry $3.9 million in 2015, up from $0.1 million in 2014. Cash flows can be affected by changes in working capital and so the true cash generative power of the business may be different, but these figures provide an approximation.
During the year, Alliance switched to outsourcing its heavy maintenance work which is expected to deliver savings. Capital expenditure was $27 million in 2015 and under the new arrangement it is expected be around $20 million per year.
If these savings are realised, the company would enjoy much improved free cash flows, which could be used to reduce debt or pay dividends. Net debt fell by $10 million to $84.5 million during the year and the company elected not to pay dividends.
The debt repayment was funded through the sale of two aircraft for $12.4 million. This was $3.2 million less than their book value and so a loss was realised raising doubts over the book value of the rest of the fleet. However management has indicated that since the impairments, the carrying value of these assets now more accurately reflects their market value.
Outlook
Mining activity continues to contract and so I expect Alliance will struggle to grow revenues over the coming years. In order to counter this effect, the company recently diversified into the tourism industry and in December 2014 won a long-term contract with US tour operator, Tauck Inc.
Revenues should remain fairly stable since despite what some would have you believe, the mining industry is here to stay. Cash flows are likely to improve if the company can reduce its capital expenditure as planned and so debt will continue to fall.
I won't buy shares in Alliance because I don't think the business is worth much more than its $55 million market valuation, especially when factoring in debt. Also, I believe the best long-term returns are made by investing in high quality companies with plenty of room to grow.
Follow the links below to find out the name of one such company identified by analysts at The Motley Fool.
