Monday, July 30, 2012

Dart Group Plc -- Air Transport & Supply Chain Logistics

The UK's Dart Group operates a supermarket logistics business (Fowler Welch) and a holiday airline serving the UK market north of the Midlands (Jet2). 

It is a favorite of the value blogosphere. It has been comprehensively covered here, here, here, and even here.  

This is the bird's eye view of Dart:

It seems extravagantly mispriced at a market capitalization of £107 million. 

Some thoughts:

Fowler Welch is entirely severable from the airline segment of the business. For various reasons, it seems to me quite probable that this business will be sold as soon as it reaches operational maturity -- perhaps in one or two years. The most likely scenario in that eventuality is that the proceeds will be distributed to shareholders as a special dividend. Meeson doesn't seem to me to be very interested in Fowler Welch and, since he owns 40% of Dart, a £24 million cash payout would serve his interests quite well.

This is Fowler Welch:

and the following is a more or less current set of trading multiples for a basket of businesses similar to Fowler Welch:

At 10x EBIT, Fowler Welch would sell for £60 million.

Adjusting the current market capitalization by that amount places a £47 million value on what remains, an airline and package holiday business that generates normalized operating profit of £38 million per year:

Three factors explain Jet2's high return on invested capital: (1) eight "Quick Change" 737 aircraft put in extra shifts transporting cargo under contract to the Royal Mail; (2) Jet2 Holidays has done a good job of funneling additional passengers to the airline, adding 3 to 4 percentage points to the load factor; and (3) ancillary revenue generation is high -- twice as high as Easyjet and Ryanair.

(That Jet2 operates 22 year old aircraft is a wash -- lower depreciation costs are balanced out by higher maintenance costs). 

So £38 million seems to me a defensible estimate of of Jet2's profitability, at least in the medium term. Over a longer horizon, I think it reasonable to assume that Jet2's profitability will tend toward  £20 million: there is nothing that it does that could not be copied by an entrant into its market, and the ROIC will revert to a more normal 17%.

At £20 million, it would be yielding 45% rather than 81%.

What of the £152 million in cash? It is tempting to think of this as distributable to shareholders. But I don't think it's quite so straightforward. In my view, Dart needs to keep 80 days of cash on the books (to correspond with its trade receivables collection cycle) in order to avoid even the perception of a liquidity crisis should it ever step off the growth escalator. 80 days of cash is currently £117 million. Excess cash -- the amount that could be paid out to shareholders without in any way affecting the business -- is then £35 million, reducing the cost basis of Dart's equity further, to $12 million.

This, then, is my perspective on Dart's valuation at the current share price: a £12 million investment in a business, Jet2, that, in the medium term, will likely generate £38 million in annual owner earnings (for a 316% yield) and that, over the long term, will probably generate £20 million per year (for a 167% yield). As I say, Dart seems extravagantly undervalued. 

A more reasonable minimum market capitalization would be £260 million, equivalent to a share price of 177p. And it seems to me that Dart will realize that valuation if and when it sells off Fowler Welch.

If Jet2 grows profitably, as a result of its new hub in Glasgow or its foray into transatlantic flights, that valuation should be revised upward.  

Disclosure: I do not have a position in Dart, however I may initiate one if the share price falls below 65p.


  1. Fascinating. Do you always buy at such a big discount to your estimate of value? Or are you particularly unsure about Dart?

  2. I always want something valuable for free (that's what value investing means to me; always, always get something valuable for free). In Dart's case, I'd like Jet2 for free -- and that means a share price of 65p.

  3. "What of the £152 million in cash?..."

    Particularly agree with this paragraph. I've read people elsewhere talking about distributing the cash to shareholders, but I'm with you in it not being that simple. It is illusory cash from their trade cycle - still good cash to have, since it wards away any liquidity problems - but that is its purpose. Distributing it means you are running a business inherently leveraged to future growth to finance your current operations, and as a shareholder I'd be very wary about that!

    I hadn't thought about separating the cash for their cycle from actual free cash, but that makes sense.

    Thanks for the post.

  4. Thanks for the comment. It's odd to me that I've now profiled two airlines, both run by Brits, since I'm usually (and fashionably) leery of the airline business. But there you are -- sometimes the market behaves in mysterious ways and offers up a temptation or two.

  5. Another good write up. Just the one question from me this time:

    How come on this occasion you aren't capitalising operating leases and adjusting your valuation accordingly?

    When I run my version of what is a reasonably similar model to yours I do include that and the current market cap still seems attractive.

  6. I didn't have a number for 2012 rent and didn't feel comfortable making one up. I also knew that I was going to treat Fowler Welch & Jet2 as separate businesses and base the valuation on that rather than on the overall picture in the first table.

    Note that if I had done it the proper way -- the way that you suggest -- average ROIC
    would be 20.77% and the return on new investment would be 330%. This is a company that is doing something very right, at least for the moment.

  7. Yep I have average ROIC as very similar to that. As for the operating leases; if you turn to page 66 of their latest annual report, you can see that they have £18.7m falling due within the next year - large increase from last year but that is to be expected considering they doubled their leased planes.

    I guess the market doubts their ability to defend their competitive position in aviation and isn't really giving any credit for the distribution business.

    However, I'm provided a lot of comfort from the fact that they fly out from the second tier airports where the big players don't have large presences. For example, they have 4% of their capacity at Blackpool airport, where none of the big companies (e.g. easyJet and Ryanair) operate at all.

    Scroll to the bottom to see the airlines that operate here - all small players, with Aer Lingus the biggest.

    In fact, so limited are easyJet and Ryanair's presences at these airports, that TUI Travel and Thomas Cook are by far their biggest competitors. Thomas Cook are in a lot of trouble with their creditors and are having to cut back, leaving Dart and TUI to scoop up market share - I've seen that Thomas Cook have closed several of their high street stores around me, for example.

    I have an interesting report from a UK broker, who lays out the competitive position if you have an email address and would be interested in reading it (you can just set up a spam one if you like). My way of returning the favour for you answering all my questions.

  8. I agree that it doesn't have the barriers that Hawaiian seems to have. However, I think they do have a fairly strong competitive position. As you'll see in the report I'll send you tomorrow they offer the most routes at all their airports by quite a margin, so do have some economies of scale.

    However, in the interests of being conservative, I think your assumption is probably a fair one.


Note: Only a member of this blog may post a comment.