Gama Aviation (LON:GMAA) today announced a profit warning after stating that trading in some of its divisions was below expectations. The profit warning was enough to send the share price reeling at the open by some 20% and the price of the shares have fallen steadily all year: we are now at less than half the price we were at the start of 2018, and the price is revisiting its lows of the year before:
In truth 20% is a small mark-down nowadays for a firm announcing a profit warning: perhaps this reduced figure takes into account that GMAA was already quite cheap, and now is even cheaper. Following on from the back of the Flybe warning, it can easily be seen that aviation is not a good sector at present with plenty of headwinds, although arguably Gama is a markedly different company.
Gama Aviation is not an airline in itself, but rather offers a range of aviation services, from maintenance of aircraft to charter flights as well as pilot training. They are an extremely diverse business in a diverse range of locations. As such they are in some ways dependent on the fortunes of other airlines but in other ways can create their own business, for example in the growing field of charters.
It is an exciting field to be involved in with some significant barriers to entry. But those barriers to entry also present some big challenges. Many of the costs aviation companies face are large and fixed in nature, and other major inputs are subject to large fluctuations in price. There have been numerous airlines which have ceased to operate in the past year alone and there is substantial proof that when things start to go wrong it is very difficult to turn it around because of the committed costs.
The warning is mentioned right at the start of the trading update:
At the time of the H1/18 interim results substantial growth was anticipated in the 2ndhalf of the year. However, with Q3 delivered and with better visibility for the full year, trading in certain divisions has not improved sufficiently to deliver the full year expectations.
As a result, whilst no individual division is significantly weaker, in aggregate there is a material impact, and accordingly the board now expects the full year underlying operating profit to be $3m below its original expectations. Nevertheless, the investments made into the capacity and capability of the business during 2018 have progressed well and provide a robust operational baseline for continuing the execution of our strategy into 2019.
$3m is a significant profit miss in terms of figures, as the underlying profit in the year before was $17.1m. The CEO rounds this off on a bullish note:
Nonetheless, we are still expecting healthy growth for the year whilst continuing to make good progress in building capability and capacity and securing encouraging new business in all of our key markets. The fundamentals of our business remain strong.
It is fair to say that the business is still expanding. In February this year a new placing raised $67m, notionally to buy out a partner in its Hong Kong operations, upgrade maintenance bases and to target acquisition targets.
As of last month, much of this cash still sits within the company, helping it swing a position of net debt of $13.0m the year before to a net cash position of $21.1m.
Their financing facilities were also renewed in August 2018 for another 4 years providing a $70m facility, which clearly they have not made the most of at present. With a pipeline of acquisitions planned, it does seem logical that the net cash balance will rapidly diminish, or even turn negative, but there is no immediate threat to the business.
It is fair to say the balance sheet is not as strong as others. Due to the acquisitive nature, there are over £50m of goodwill and other intangibles parked on the balance sheet. The shares trade underneath book value when this is taken into account.
Income is slightly lumpy, but this is to be expected with the industry: an average customer is likely to be a very large business themselves. It is interesting that the majority of their income is contracted: Gama provide services such as air ambulance services to local authorities as well as scheduled maintenance.
There are a lot of moving parts to this business with its many divisions and arguably it could be too complex to understand for the average investor. Demonstrably it can be easy to see that we might be in growth markets with an increasing demand for air travel and charters, particularly in the Far East. Gama can even benefit from that even when they do not operate the aircraft, because they also offer maintenance.
On the flip side of this a growing air of cynicism towards placings and whether initial predictions have been too optimistic in order to get a deal over the line. Gama’s growth has been less than expected and another risk factor mentioned is a loss of contracts. Expansion into Asia/Middle East could be seen as difficult, particularly now their partners have been bought out. As we have seen with Keller, differing conditions make it very difficult to simply replicate a performance.
As mentioned before the upsides are plainly easy to see here. If Gama can position itself correctly in the developing markets they could be a international services provider, and a significant one at that. If that is the case, the share price valuation would be many times in excess of what it is today. My nagging feeling is that market leadership would be very difficult to establish, either on cost or quality grounds.
This could easily change depending on the nature of the acquisitions. It may be the case that Gama can simply buy their way into the markets and establish themselves from there. At present I am undecided, so will rate it at 3/5.