Aviation service specialist John Menzies (LON:MNZS) today slipped to a profit warning as it revealed that a challenging aviation market this year has impacted demand for cargo services, and consequently any profit rise will be snubbed out. The share price plunged 20% in early trade although has since recovered about half of this:
The longer share price chart for Menzies is rather grim. This profit warning is the latest in a steady 2-year decline in its share price, and it has lost half of its value since the summer of 2017.
It is fair to say that we do not need any special insight to realise this indeed has been a tough year for aviation. The troubles surrounding the Boeing 737 Max are simply the latest in a long line of adverse news which has seen several airlines bite the dust in recent years. On the flip-side we could still postulate that in the long-term, aviation will continue to grow as it becomes more affordable.
Menzies is an interesting company. Originally a newsagent, the company expanded into the distribution of newspapers. Very recently, the company has become a ‘pure play’ aviation specialist and exited the distribution side. It provides many services that we might take for granted at airports including refuelling, aircraft maintenance, ground handling and other services such as airport lounges. Clearly, with the number of airports growing throughout the world, this is not a bad market to be in.
The warning comes in a trading RNS. It pulls no punches to start with:
Trading across the Group has been disappointing, reflecting the challenges that the wider aviation market is currently facing driven in part by weak cargo volumes and flight schedule reductions. Against this backdrop, performance in the first half of the year has been below expectations and consequently the Board now believes that earnings for the full year are not expected to exceed last year.
There are several measures to earnings here, would presume this may be referring to underlying. There is some news on what is being done:
As previously announced, the Group has been implementing several actions including a cost rationalisation programme that will deliver at least £10m of cost savings, the majority of which will materialise in 2020, a revitalisation of our commercial offering and a greater focus on returns from the deployment of our systems.
Overall the Board believes that the medium and long term fundamentals of, and prospects for, the business are sound and remain confident that the actions being taken in the current year underpin the Board’s expectations for 2020.
Forecasts for FY2020 are ambitious from here, so this may provide some reassurance for investors.
It is evident that the accounts may be harder to interpret due to the fact that distribution activities are now discontinued. In recent years, the company has fallen on tougher times as the levels of profit have decreased:
The loss in the past year was due to adjustments including a writing down of intangibles. Whilst the group is re-organising itself I would expect plenty of these costs.
What is apparent is that there is a lot of business being carried out here for the company to earn its profits. Providing these activities is therefore quite a low margin business. The factors behind this would be large competition on a largely generic product, and an increasing sensitivity of cost even on legacy airlines. Short-haul European travel for instance on British Airways is not too much different from a low-cost airline.
Selling the distribution arm on some aspects did not make sense, despite the company rationale. This division contributed £20.2m in 2017, and £21.7m in the year before. Certainly, we can see that newspapers may be in terminal decline, but this was a significant contributor to profit. But perhaps in the context of the balance sheet, this makes sense. John Menzies is not in a great financial position and money is needed. It has a bad pension deficit position, which ate up approximately £20m in the last financial year and the year before. This deficit has been reduced, but contributions in this year will still total almost £10m.
Net debt is also a worry. At the last accounts this figure stood at something close to £200m. However, this is still within the borrowing limits (£150m sterling revolving credit facility, $250m loan). Considering the levels of intangible assets on the books, the net tangible asset value was slightly negative although this should have improved by now
It does seem to be an expensive business to keep on the road. Capex expenses are high, and in many of the years exceeded operating cash flow. Menzies also have paid dividends, and in turn this has been above the levels of free cash flow per share. This goes some way to explain the increase in debt and also dilution of shares which have taken place in the last few years.
It is notable that roughly only 75% of shareholders approved the last directors remuneration package, and the CEO has left since the last accounts.
Menzies have come down to a reasonable valuation and some might say cheap – £327m for a company that had underlying profit of £44.1m in the last results in an industry with developing opportunities could be a good thing. This figure masks quite a few issues with the company however: the large debt which interest has to be paid on, the pension fund deficit which eats up profit contributions, large capex requirements. Additionally the company is losing an established division and has moved to restore these lost revenues by expanding into aviation related fields, hence the pure play.
The dividend yield is reasonable at over 5% if we can believe it will not be cut. At the moment I do believe this could be likely. Despite the sale of the distribution division, further moves should be underway to strengthen the balance sheet. The most likely way of doing this is reducing debt levels, which would then also reduce the net finance charge. Another way could be a rights issue.
The profit warning today does not make for great reading, although it should be very likely that aviation bounces back sooner rather than later. If the cost savings materialise and markets recover, todays price could have quite a decent upside. A result similar to last years would not be optimal, but neither would it be totally disastrous.
With the current low margins and weaker balance sheet I don’t believe this is a great investment at present, although there is scope for change in future. 2/5.