Flughafen Wien AG

Shares of Flughafen Wien AG offer the chance to invest in critical world-class infrastructure at a singularly low valuation. Flughafen Wien is insulated from competition, only modestly leveraged, and its services are critical to the modern economy.

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Long-time readers may know I have an affinity for businesses that are insulated from competition and enjoy at least a degree of pricing power. Past examples include Jungfraubahn AG (nobody’s constructing major new tourist railways in the environmentally-sensitive Swiss Alps) and Logistec Inc. (Cargo needs to be loaded and unloaded at a specific port. There are few alternatives.) Shares in companies like these exhibit highly desirable “equity bond” characteristics where long-term shareholder returns will approximate the current earnings yield plus organic unit demand growth plus inflation. The best of these companies rarely experience declining or stagnant earnings due to the critical nature of their operations and their strong competitive positions.

Because of the stability and strong long-term outlooks that these businesses typically enjoy, they often trade at bond-like earnings yields. Not so for Flughafen Wien. While competitors offer free cash flow yields as low as 3%, Flughafen Wien offers a free cash flow yield of nearly 8%, despite a strong outlook.

So what does Flughafen Wien actually do? Simple. The company owns and operates the Vienna International Airport along the Danube River to the south-east of Vienna, Austria. Additionally, the company owns a 48% interest in Malta International Airport and a 66% interest in Slovakia’s Košice Airport. The Vienna Airport is, of course, the company’s major asset. The airport was originally built in 1938 as a military facility, then taken over by the British following World War II. The Austrian government expanded and improved the airport over the following five decades, and privatized it in 1992. Today, just 11.8% of the company’s shares are freely floating. 50% are owned by local governments and an employee ownership plan, and 38.2% are owned by a major Australian infrastructure investment group, IFM Global Infrastructure Fund. IFM has expanded its ownership aggressively in recent years, but more on that later.

About 55% of the company’s revenues are its airport operations: collecting income from passengers and airlines who use the airport facilities. The next biggest segment is “Handling” at 23% of revenues. Handling refers to a variety of activities including prepping aircraft between flights, loading and unloading cargo, security services, and other services that ease the movement of passengers and aircraft. A further 20% of revenues consists of retail and property revenues associated with parking, rents on commercial storefronts and restaurant spaces within the airport, advertising space, and more. While it is the smallest of the three major revenue segments, Retail and Properties actually accounts for 48% of the company’s operating income. Airport operations are the second most profitable segment, making up 37% of EBIT, while Handling contributes less than 10%. The graphic below from the 2015 annual report illustrates this more clearly.

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Recent years have been good for the Vienna Airport with steady passenger growth and rapid improvement in financial results. This is despite weak economies and instability in destinations to Vienna’s east, especially in Russia and Ukraine. From 2010 to 2015, annual passenger movement at Vienna International Airport rose at an annual rate of 3.0%. Strong operating leverage (a high percentage of fixed costs vs. variable costs) allowed operating income to rise by 6.9% annually over the same period. Meanwhile, net debt has been cut in half.

Things were not always so rosy at Flughafen Wien. As recently as 2011, the firm was troubled by massive cost over-runs in the construction of its Skylink addition to Terminal 2. But a new management team and a scaled-back capex program righted the ship and the company is now on solid operational and financial footing. At Eur 22 per share, Flughafen Wien trades at less than 8x EBITDA and a P/E of 17.2, with a free cash flow yield of 7.8%. This represents a very large discount to the valuations of other major European airports and airport groups.

The graphic below displays financial statistics for other publicly-traded European airport operators. Figures are in millions USD using today’s exchange rates.

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You will see that Flughafen Wien’s valuation compares very favorably to its peer group, despite above average revenue growth and below average leverage. The only area where the company comes up short is its operating margin, which is slightly below its peers. The Copenhagen is the clear superior operator of the group, with excellent revenue growth and margins. But that is fully reflected in its premium valuation. The only other operator with similar figures to Flughafen Wien is Fraport AG. However, Fraport (which operates the Frankfurt airport) suffers from sub-par operating margins and carries a large amount of debt.

So why does Flughafen Wien trade at a material discount to its peer group? The biggest reason is likely the market’s nervousness about the company’s major destinations outside of Western Europe. Departures to Central and Eastern Europe were down 5.3% in 2015 and down 14% from the peak in 2012. Moscow in particular has experienced a serious decline. The market likely fears further declines in departures, which is entirely possible given the threat of Russian aggression and continued sluggish economic conditions.

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Then there is the prospect of major capital projects on the horizon. Flughafen has elected to go forward with a project to modernize and expand its facilities, to the tune of Eur 500 million between now and 2023. The company says the project will enhance its profits, especially via the creation of additional shopping and restaurant space, but investors may be justifiably nervous about potential cost over-runs and delays. Investors may have short memories, but their memories are not short enough to forget that a botched expansion nearly brought down the company only five years ago. I believe this risk is mitigated by the new management team and Flughafen Wien’s very reasonable leverage, but the risk remains.

Finally, there is the fact that Flughafen Wien is one of the smallest public European airport operators, with few shares in public hands. The 11.8% of the company held by the public is worth only Eur 218 million at current prices, ruling out investment in the company for most infrastructure funds and other investment companies of size.

And that’s where the opportunity lays. Readers should know I have absolutely no qualms about investing in controlled companies, so long as the controlling shareholders are motivated to increase shareholder returns. This is certainly the case with Flughafen Wien with IFM owning nearly 40% of shares. There is also a meaningful possibility that IFM will take steps to further increase its ownership. IFM’s first tender offer came in November 2014. IFM paid 20.50 Euros (split-adjusted) per share and netted 29.9% of the company. The second tender offer made in April 2016 collected another 8.3% of shares. This time, IFM paid Eur 25.00 (again, split-adjusted) per share. What price might IFM offer in a third round? Whatever that price may be, another holder of Flughafen Wien stock thinks previous offers have been far too low. The UK’s Petrus Advisers put out a presentation supporting its view that Flughafen Wien shares are worth as much as Eur 36.50 per share, after accounting for the 4-for-1 share split that Flughafen Wien recently did.

It honestly concerns me little whether IFM tenders for the rest of the publicly-held shares or not. I am happy to hold a top-quality infrastructure asset at a low-grade valuation for as long as the market allows me.

Alluvial Capital Management, LLC is launching a private investment partnership. If you are an accredited investor and are interested in learning more, please contact us at info@alluvialcapital.com.

Alluvial Capital Management, LLC holds shares of Flughafen Wien AG. for client accounts. Alluvial may buy or sell shares of Flughafen Wien AG at any time. 

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

Brief Update – Announcing Alluvial Fund, LP

I am pleased to announce that my investment management company, Alluvial Capital Management, LLC, will be launching a private investment partnership. Sitestar Corporation will be providing $10 million in seed capital for Alluvial Fund, LP. You can read their press release here.

Details are very preliminary, but we are targeting a January 1, 2017 launch date. If you are an accredited investor and are interested in knowing more, please send me an e-mail at info@alluvialcapital.com and I will provide additional information as it becomes available.

In other news, I’ll be in Philadelphia on October 24th and 25th for The MicroCap Conference. Previous conferences have been great opportunities to hear from some promising small companies and to network with other investors. I hope to meet some readers there.

 

Value in my Own Backyard – Allegheny Valley Bancorp and Standard Financial Corp.

On Monday, two Pittsburgh banks announced they would combine in a merger of equals. Allegheny Valley Bancorp (AVLY) and Standard Financial Corp. (STND) each have long histories in the city and the surrounding region. Allegheny Valley Bank was founded in 1900 as an alternative to local banks controlled by industrial titans like the Mellon family. The bank stood firm through the Great Depression and the steel industry collapse that rocked Pittsburgh in the later 20th century. Standard Bank is equally venerable, founded in 1913. While Allegheny Valley focused on urban Pittsburgh, Standard Bank grew its base in the suburbs and small cities to Pittsburgh’s east, eventually expanding into Western Maryland. Originally a mutual bank, Standard demutualized in 2010. Following the merger, the surviving entity will be named Standard AVB Financial Corp.

I have followed these banks for some time, observing the business practices of each. Both are well-run, if somewhat unremarkable. For its part, Allegheny Valley has focused on maintaining a conservative balance sheet and paying a robust dividend, while Standard has followed the optimal post-mutual conversion playbook of repurchasing shares and increasing its dividend over time. Still, each bank suffers from the problems facing most small banks: sub-par ROEs from compressed interest spreads and rising compliance costs, and a lack of growth caused by low loan demand and insufficient marketing and technology resources. I believe the proposed merger will do much to alleviate these headwinds, leaving shareholders in the combined entity extremely pleased.

Competitive Position

At present, each bank is only a blip on the local financial radar. Allegheny Valley has a deposit market share of just 0.3% in the Pittsburgh MSA, while Standard’s Pennsylvania operations have just 0.2%. The combined entity will control 0.5%. Still small, but sufficient to vault the combined entity to 15th place among local banks from the current 20th and 25th positions. A higher market share will benefit the combined bank via improved marketing efficiencies and better geographic coverage. Standard AVB will blanket Allegheny County and adjacent Westmoreland County rather than one or the other.

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Efficiencies

I am always skeptical of projected cost savings in mergers, but bank mergers typically do realize substantial savings. Many duplicated functions can be reduced or eliminated when similar banks combine. Allegheny Valley and Standard are projecting a 16% reduction in non-interest expenses, which comes to $3.5 million pre-tax on a trailing twelve month basis.

Balance Sheet Rationalization

Presently, Allegheny Valley Bancorp is over-capitalized and Standard Financial Corp. is highly over-capitalized. Allegheny Valley’s common equity-to-assets ratio is 11.8% while Standard’s is 15.1%. The combined entity will have a 13.6% equity ratio. This strong capitalization will allow for a better return on equity than Standard currently manages, plus greater capacity for growth investments and/or acquisitions than Allegheny Valley’s balance sheet allows at present.

The proposed merger also strengthens and diversifies the banks’ loan books and deposit bases. Standard’s loan book is dominated by traditional residential real estate lending, while Allegheny Valley is much more involved in commercial lending. Standard relies heavily on CDs and traditional savings accounts, while Allegheny Valley has a much higher percentage of lower-cost (but potentially transient) demand accounts.

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Valuation

Allegheny Valley Bancorp shareholders are to receive 2.083 shares of standard per AVB share, or 46% of the resulting business. The surviving entity will have 4.78 million fully-diluted shares outstanding. The combined bank is projected to have equity capital of $128.5 million at the end of the first quarter of 2017.

Standard’s shares have traded down meaningfully following the merger announcement. I suspect this is because a large number of Standard’s shareholders had expected and desired a buyout by a larger bank, as is common for a recently converted mutual thrift. These shareholders may be displeased at the prospect of Standard remaining independent, even as part of a larger, more efficient organization. Standard’s shares closed at $23.80 on Thursday, down 8% since the merger was announced. But this decline only highlights the prospective value. Pro forma book value following the merger is $26.88, putting shares of Standard at 89% of book value. Earnings will take a temporary hit due to severance and restructuring charges, but forward earnings power will benefit from cost savings. Assuming the stated cost savings projections are met and a 40% tax rate, the combined entity’s annual earnings should increase by $2.1 million, or 44 cents per share. That benefit plus each bank’s trailing earnings would put earnings per share at $1.92 for a pro forma trailing P/E of 12.4. And again, this is for a bank with a very “lazy” balance sheet. Standard AVB Financial has a clear path to earnings growth through balance sheet expansion. The combined bank could expand its asset base by 60% and still maintain an 8% common equity to assets ratio.

While I think shares of either bank are attractive considering the proposed combination, shares of Allegheny Valley are priced at a 2.7% discount to the deal value. (The discount is actually larger once Allegheny Valley’s generous dividend is factored in.) I like both the current discount to book value, the solid earnings yield, and the strong prospects for earnings growth. For anyone interested in beginning due diligence, here’s a direct link to the merger presentation.

There is one more interesting wrinkle. Another Western Pennsylvania Bank, S&T Bancorp, owns 14.2% of Allegheny Valley’s shares. S&T will own about 6.5% of the combined bank, making S&T the largest shareholder. A future tie-up with Standard AVB Financial would solidify S&T’s status as a top 10 bank by deposit share in the Pittsburgh MSA. Not saying it will happen, but S&T is acquisitive.

Alluvial Capital Management, LLC holds shares of Allegheny Valley Bancorp and Standard Financial Corp. for client accounts. Alluvial may buy or sell shares of Allegheny Valley Bancorp and/or Standard Financial Corp. at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.