Dart Group (DTG)

Come Fly with Me

And then there was one! My portfolio has but one member left without a detailed post, and it’s certainly not for lack of interesting things to say. On my meandering journey through the stock markets, Dart simply got left until last, in the meantime underperforming both my portfolio and the market quite significantly. As I said when beginning this series, I find stocks that fellow value investors have bought which have then declined fascinating. If I agree with their initial logic and nothing has changed, I’m presented with an attractive opportunity made even more attractive by the fact it’s now cheaper than ever. Dart’s down nearly 20% on the back of weak consumer confidence and spending – but if these trends are cyclical as I believe, the long-term prospects of the business are as rosy as ever.

Unusually, the metric box on the right combines two of the most attractive features of the stocks I’m after; it is both cheap on an earnings basis, trading at 6.2 times last year’s earnings, and on an assets basis – £1 invested in Dart buys you more than £1 worth of tangible assets, and hence your downside is reasonably protected. Perhaps the only disappointment is the weak dividend yield, which as discussed last post is the first sign of management intent I’m looking for. Still, forward earnings are forecast to be even stronger, and it’s that combination of factors that initially drew me to the business.

The metric graph is a little dizzying, and makes long term trends difficult to see, but that comes with the business – Dart operate both a low-cost airline and a distribution business, mostly based in the north of England. Margins are fairly thin in both these segments, and highly sensitive to cost pressures – with Dart having to absorb greater fuel costs, for instance, while being unable to pass costs on to particularly price sensitive consumers. Operating a low-cost operator in a recession only exacerbated that problem!

What we do see, though, is a strong revenue jump in the last year, driven by the aviation side of the business. Broker forecasts see a continuation of that trend, with another 15% hike in revenue next year as the continued expansion of the company’s asset base kicks in – both additional aircraft and a large new distribution centre made up most of last year’s capex. Visibility of revenues in the aviation segment is helped by a large order book – last year comprising £121.4m against £398.7m of end-year revenue. This year the order book is £177.1m –  a very promising increase. However, with brokers forecasting a 15% hike in revenue when we’ve seen nearly a 50% increase in the size of forward orders, the statistics piqued my interest. To what level do forward orders correlate to end year revenues?

The graph left below shows end-year revenue vs. start-year order book, and we see a tight fit indeed  – historically, revenues have come in at between 3.3 and 3.5 times the order book at the start of the year. That holding so tightly true for the last 4 years is certainly interesting. For comparison, if we take 3.3x order book for this year’s aviation segment revenues, we get a figure of £584m for aviation revenues – if we simply add in a flat distribution segment, we arrive at full-year revenues of £728.6m – over £100m higher than broker forecasts. Certainly a discrepancy! If the historical norm holds true, then, we could see significant upside on the revenue front – and that’s without even considering the growing distribution segment.

The problem is, of course, margins – shown in the graph above middle. They’re not at all stable, and recent management communications seemed decidedly shaky on that front – noting that they ‘hoped’ to meet market expectations, but economic conditions meant they could not past on cost increases. Valuhunteruk has an excellent post on Dart Group and margins, but my summarised views come to more or less the same as his – margins are volatile and unpredictable, but don’t need to do anything spectacular to make Dart look like a cheap company. Short-term they make look depressed, but in the medium term any sort of reversion to old margins would make the company appear very cheap. If we take £750m revenue for 2013, for instance, which seems a good target, Dart earning the 5% margin they seem to float around would leave net profits around £28m. Applying a sceptical market valuation of 10x earnings, that would value the company at £280m – 160% upside from the current price.

‘Finding a valuation undermanding’ is an infuriatingly common City phrase, but I can’t think of anything better to sum up shares trading on multiples like Dart – it really doesn’t have to do much to appear cheap in a few years time, and with growth prospects looking strong as well, it has to fail on most fronts to look expensive. Practically speaking, we’d need to see below forecast revenues (defying the order book), margins once again steeply depressed, and no end in sight for the consumer confidence drought. It’s far from impossible – in fact, one or more of those things may likely happen, but I’d see any one of those factors coming through as a great sign for Dart’s prospects.

Operationally speaking, then, I’m bullish – so it now falls to explain that low price to book value. A great deal of Dart’s assets are tied up in property, plant and equipment (see chart above) – unsurprisingly for an airline, most of this is aircraft and engines. This large fixed asset base is played against only a tiny amount of long-term debt. In Valuhunteruk’s piece mentioned above, he noted the company’s large cash balance and questioned its use- similar to Interior Services, Dart have a sizable amount of ‘trade and other payables’ – in this case, deferred income. Deferred income is an interesting proposition, because it’s not ‘debt’ as such in the sense of other trade and payables – such as owing your suppliers money. It simply arises from taking payment from customers for flights and holidays in advance of providing the actual service.

Hence, the cash on hand is once again basically a free source of working capital. Most business absorb cash flow risk – builders, for instance, build first and sell later. Dart reverse that, and hence have no need for complicated financing arrangements. While the company is growing revenues the churn of customer deposits looks set to continue, and the cash on hand will likely continue to grow – particularly looking at the group’s cash flow statement, which is exactly what we like to see – depreciation may sharply impact headline profits, but cash is still coming through.

Ideally, I would like to see some of this cash returned to shareholders. The dividend is particularly disappointing in relation to the profits – while the stock is on an earnings yield of over 16%, their dividend yield is only 1.6% – covered 10 times over. With no long term debt and a great deal of fixed assets, borrowing would probably be relatively cheap for Dart. While it sounds like anathema for a value investor to advocate debt, the trade off between debt and equity is undeniably logical – and I suspect shareholder returns would probably be significantly boosted if the company were to buyback shares or pay and dividend and use a credit facility for working capital management instead of holding so much dead cash.

Still, I digress. What makes this stock appear cheap is exactly the fact that what I’ve said above hasn’t happened yet, and we’re thus left with a strongly cash-generative business growing revenues and sitting on a solid balance sheet. What they decide to do with their money is of interest to me, but not fundamental to the investment decision – that’s based on the operating position. At a P/E of 6.2, as with many of my investments, I just think the balance of risks are tilted in my favour.

9 Replies to “Dart Group (DTG)”

  1. Calum Russell

    Nice work on the order book multiple. What was your opinion of the AGM statement? I don’t think I quite understand the projections/expectations atm (I actually still have ones for the LFY which were way off on rev but spot on for EBIT). Oil is off quite a lot and I can’t see how distribution can fail to do worse with all that new capacity. The AGM statement made me feel like I was missing something. (the comment about increased load factor, smaller yields was quite interesting tho)

    • Lewis

      Hi Calum,

      I was a little surprised at the choice of wording for the last line of the AGM:

      “Overall, the Board still hopes to meet market expectations for the current year.”

      ‘Hopes’ is a terribly loaded word. Expects I like, hope I don’t; somewhat disappointing, as I didn’t think Dart’s consensus forecasts looked too challenging given all the factors discussed. I guess I’m trying not to think too much about short-term macro softness. It was hardly unexpected, and Dart looks solid in the mid to long term regardless of short-term fluctuations. I feel I may be missing something too, but I think I may have to wait for a more detailed management statement to figure out what it is!

  2. Andrew Robinson

    Having been a 3% holder from the 16p days i agree with most of what you say.

    However…………many new aircraft are needed and that is where cash should go. I am not a debt man.
    I have reduced my stake (well i did at almost 100p), but having been looking at a 50p bottom to get back in.
    The concern right now is OIL prices.
    The company is Busy…………i saw 9 aircraft moving at Manchester yesterday.The transport division is gaining market share.
    My one disagreement is that you will never get a valuation on DTG of 10x.
    Meeson (not liked) owns 40% and company does NOTHING to promote itself.

    Other than that, it was a good insight and close to my numbers
    cas tiger

    • Lewis

      Hi Andrew,

      Seen you around a few of the iii boards I think – thanks for the comment.

      Everything you say seems fair enough. I’m not hugely concerned abou the cash balance as it is just advanced for work they need to complete.. it’s hardly as if they’re just hoarding cash – it’s just a buffer and mitigates some cash flow risk.

      I also suspect DTG may never be particularly well rated. My biggest gripe with the company is the poor payouts to shareholders. One way of looking at dividends is in terms of dividend cover. At something like 10.5, the glass half full position is that the dividend is well covered and safe. My sceptical point of view points at the inverse of the dividend cover (1/10.5) which represents the proportion of their profits they’re paying out to shareholders. Less than 10% is rather poor.

      If Meeson didn’t own such a significant chunk, I would be worried about the alignment of shareholder and investor returns. After all, the company keeping lots of money is fine, but only if (as you say) they actually use it productively. New aircraft is a productive, profit producing use of money.

      Lots of different factors at play. If they wanted immediate share price appreciation, probably best to hike up the dividend. As someone who tries to be a long term thinker though, I don’t mind if they keep the cash and invest – as long as at some point in the future I see the benefits!

      • Andrew Robinson

        Well…………its all looking very good again. 200 million of cash and over 100 of that is FREE so to speak.I think low 20`s EPS poss as high as 23/24 for this year increasing to high 20`s next year.
        Forward bookings are better for winter and well ahead for next summer. 11% increase in capacity and oil prices fairly stable. Which ever way you look at it even after the recent strong run the shares are still undervalued.
        If we finish with high 20 million profit then shares could/should be around 200p plus.
        The great thing is the quality of the balance sheet with only 7 million goodwill. The cash is being spent on property (the hub) and real assets that go on to make money. I really like this and can see a steady rise now to 150 as we have little news till april with the next IMS.
        I am happy to be back and would look to buy many more on any weakness in the market.

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