Gama Aviation (LON:GMAA) today issued a further profit warning as it posted its 2018 full year update and an outlook for 2019. The share price has declined another 30% today, although it pulled back after the market opened:
In truth this has been a precipitous drop over the past year: the shares now trade at a third of their value and it has been a poor time for shareholders. We wrote about Gama Aviation’s first profit warning last year and it was rated 3/5. Since then, there have been further difficulties industry-wide, with Flybe among the main strugglers.
As mentioned before, such events might not be that relevant to Gama: they are not a airline in itself, but provide a raft of other services that airlines might like: maintenance, pilot training, charter flights. It may be not too difficult to see that a company like this would be difficult to replicate without having a lot of cash, as there are very high fixed costs, which provides a barrier to entry. On the flipside, training and maintenance is something that airlines could choose to take in-house, and the charter market is often unpredictable with limited visibility.
Today’s warning gets the bad news out ahead of the full year results, which are due out in March. First, we get the 2018 results out of the way, and these take a hit:
The Board now expects the full year underlying operating profits to be $3m below its previous guidance, provided on 29th October 2018, due to:
· Accounting adjustments resulting from a comprehensive balance sheet review process carried out by the new finance team
· Changes in accounting treatment of certain organic investment costs
· Lower than expected share of associates profits, principally in the US
· Positive but lower than forecast trading growth in Q4/18
That is bad news. The 29 October warning said that profits would be $3m under the original guidance, so this appears to take another $3m off that. The reasons are given as follows:
In the first half of the year the company incurred exceptional costs of $4.5m including costs associated with the equity raise, litigation costs and integration and restructuring costs. In the second half the company has incurred further significant exceptional costs including those associated with the move to Bournemouth, legal entity reorganisation and diligence costs on potential M&A opportunities. These costs will be reflected in the statutory reported results in 2018.
These exceptional costs were not mentioned earlier. A subsequent note comes with mixed news, as there is not much clue whether this will uncover further costs:
The Board is conducting a thorough and full review of its financial reporting methodology to simplify the presentation and improve the consistency of financial information.
A short and sweet 2019 outlook was given:
With continuing growth in the US likely to be offset by the challenging market conditions in Europe, and with M&A opportunities yet to be delivered, the Company is taking a cautious approach and accordingly expects that the performance for 2019 will be similar to that delivered in 2018.
That seems to cover up the fact that 2018 has been a very bad year for Gama, and 2019 will be a similar one.
As noted, the business is still in an expansionary stage. Last year a placing raised $67m which was used to buy out a partner in the Far East, and also reverse the debt position. From the initial comments it appears that the company is having some trouble digesting this acquisition. In January this year they acquired another company (Lotus), a Florida-based VIP charter operations company, as well as entering the Saudi Arabian market.
Underlying profit is the measure that they use, which excludes amortisation, exceptional costs, share-based payments and also the share of exceptional items in their associate. Given that the first two items seem to be incurred regardless for the foreseeable (as acquisitions are on-going) I would imagine that genuine profits are a little under this.
At this stage, the company is still trading profitably, even after this statement. But a $6m cut to underlying profits has some real effects on cash generation as the exceptional costs are still incurred.
As covered in the previous warning, the acquisitions have given the company a rather large intangible asset base:
Despite this, net tangible assets are still positive, although the quality of the receivables have deteriorated in the past year;
Receivables have gone down, and other debtors, prepayments and accrued income have gone up. No notes are given in the profit warning today about the cash position at the end of the year, and it is not clear what exactly the amount for the exceptional costs were in the second half. Given that they were classified as ‘significant’, there may even be a decrease in cash resources, given the lower profit levels. It seems that the dividend may come under pressure, but if it is believed the setback is temporary, it may well be held, as there is sufficient cash to pay it.
On a positive note, the CEO holds a massive holding in the company, at over 22% and dealings have been minimal. That can give shareholders some comfort that the company may be willing to defend the share price.
The company is still on a solid footing, with a net cash balance at the last annual report. The news today is quite worrying though. The type of second half costs they have blamed for the reduction in profits would surely have been foreseeable in the first half, and it might be that this does not tell the full story.
Even worse, the prognosis for 2019 profits are to be the same as 2018, which was dotted with the exceptional costs. So either are these costs set to continue into 2019, or are they simply setting a lower target for them to exceed? Given that Gama have won two lucrative contracts in the past year (one for an unnamed European client for servicing of aircraft), although revenues for ground services are much smaller than those for the air.
One thing is that the company has become very cheap on traditional valuation metrics: the market cap has dropped to £55m, so if profits recover to their previous level this looks like a bargain price.
Fundamentally I see little wrong with the business: there will be demand for their services, as evidenced by two large contract wins in the last month, which has added slightly to visibility of earnings. With exceptional costs surely decreasing over the years, this should translate into better profit figures.
Perhaps the main issue with this is that shareholder expectations have not been managed well, and there is little cheer in the profit warning. It seems that we may have reached the bottom, but with costs as they are in the sector things can still go bad quickly.