Nigerian Aviation Handling Company (NAHCo) Plc’s performance over the last five years, since privatisation, has been commendable with year-on-year relative growth metrics that provided some relief to its numerous shareholders. This is all the more significant when the performance is juxtaposed against other companies in the market who continue to be challenged by profitability and real growth issues.


The Bates Sule led management and board of directors have provided a success story of a privatised firm that must now begin to think about sustainable growth in top line revenue streams to match its ambitions.


Why is this important? The NAHCo Aviance success so far has been a based on its ability to read very quickly market trends and opportunities. It will have to respond to the 2010 and beyond challenges in the same breadth but with an understanding that the business model has been significantly altered by the restricted market size and caps on revenue earnings relative to the airline industry’s fortunes/buoyancy.


This is evident in:
   the reality of the Q1 2010 performance and the need to sustain forecast;
   the realisation that the company will have to deal with the twin impact of an alternate service quality offering to consumers (or competition not defined by size and scope but by the critical service offerings available to increasingly discerning clients in areas including non-traditional airline businesses) and the reduction in the time it would take for new initiatives to start contributing to turnover metrics;
   the ability to manage change at the board and management levels and the relative settling down to positively impact the performance of the company in 2010 and beyond;
   the realisation that access to cheaper sources of funding i.e. equity market may not be there to finance the much needed asset replacement needs of the company; leading to a resort to borrowing – a new learning curve for the company.


We see the management of three key issues as significant in delivering sustainable profitability for the company – its dividend policy, operating cost control and asset replacement and investment decisions.


The Dividend Policy
The 45k final dividend with 25k interim dividends to make an aggregate of 70k dividend per share is commendable. This we believe will raise the profile of the company in the market. Moreover, the fact that the company still maintain its 2.230 billion shares in issue is a welcome development, a form of leverages for higher returns in the coming years, all things being equal. The path of caution adopted by the company in resisting the urge to tow the generic line by indulging in the issuance of float-bloating scrip issue to investors/shareholders is in our opinion a positive attribute.


Yet, one must acknowledge that with the planned bond issue of N5bn by the company, the board and management who has built up a long dividend history would apparently view dividend reduction or omissions as particularly unattractive, perhaps because it would signpost them as the managers under whose tenure and policies generated insufficient cash to pay dividends. If we follow this assumption, it will be wise to assume that NAHCo may opt for a retention of its high dividend payout policy which, it appears, will hurt it as it deals with debt covenants – a step in itself that could have been reduced by years of prudence in managing the fine line between dividend payouts and profit retention for asset replacement purposes – a major driver and outlay for the bond sourced. Some form of dividend reductions may seem imminent and strategic in the light of this reality – unless of course, the firm is able to step up its revenue generation capacity based on current levels of operations. This is the first test for the new board of directors.


Beyond Repairs & Maintenance: Assets Replacement and Investment Funding
The impression of more investment in fixed assets as a means of business expansions has been created above, and rightly so, as management has touted this as the strategic imperative of 2010 and beyond. To deliver on this, a significant investment needs to be made and funded – quite unlike what has been done in the five (5) years past. We are of the view that investments in this regards seem to be below expectations. In the company’s value added allocations in the period under review, only 11% of the total value added were expended on business development and expansions.


Though with an equipment breakdown rate now few and occasional in the past two (2) years, NAHCo Aviance needs to focus its mind on addressing the need for a higher level of efficient and effective service delivery devoid of disruptions as a competitive service advantage; and it is thus expected the planned bond offer offers an opportunity to leverage the potential of the firm based on identifiable investments in equipments, replacement of aged machinery and assets for new business ventures.


Prudent Cost Management
The management of the company will do well to maintain the present prudent cost management stance which has resulted in improving efficiency ratio both at the operations level and the overall cost levels. Improved cost efficiency serves as a relief of sort and leverage for improved profitability. This in our opinion will contribute to sustaining the profit-cost metric of the company.


OTHER INVESTMENT RISKS

The business model’s dependency on strict aviation sector buoyancy: The aviation ground handling business is easily impacted by vagaries in the world economy just as it is heavily slowed down by lack of access to local funding support. This always presents a low load factor on flights with subsequent drop in frequencies. As the airlines go so does the ground handling business. NAHCo Plc must therefore contain this risk by accelerating its diversification plan into non-airline related ventures like haulage, mail handling, Diaspora cargo services, consultancy services, Aviance Ghana, executive passenger services, courier services and loyalty programmes it has planned.


Economic and Service Factors: The likelihood of accidents, disruptions to operations owing to power outages and failed generating power to the Lagos shed, stretching the man hours per day, new equipments breakdown due to overuse, air crashes, load factors, airport closures due to strikes or political upheaval, increase in crude oil prices and acts of god; will surely have an impact on the company’s earnings forecast.


Regulatory oversight and Political Factors: The NCAA is prone to knee-jerk reactions and may put in place a rule that will impact negatively airlines and/or ground handling companies like NAHCo. The NCAA is largely dependent on the government for financing and direction; the government may instil policies that work against the ground handling companies such as allowing conditions that make it easy for airlines and other players to challenge key business interests of NAHCo.


Overdependence on Lagos Airport: NAHCo Aviance’s operations (passenger traffic, flights, mail handling and cargo) are over 85% based on activity at the Lagos Airport. The vulnerability of its prime revenue contributor – cargo handling – in a Lagos airport beset with poor and near abysmal service quality, airport closures due to repairs, aviation fuel issues and other unforeseen events expected from an airport way past due for a major overhaul. These events will likely reduce NAHCo’s earnings significantly if it causes reduction in flights or outright closure of the airport. This is a reality that will happen one day and NAHCo Aviance needs to factor this into its business projections. In response to this over-dependence (driven by the reality of air traffic and cargo transportation destinations which skews the usage of airports to few airports in the country); NAHCo Aviance has take steps to expand to other domestic airports. This can only be a worthwhile move if the expansion goals also include new businesses.




NAHCo Plc’s share price in the last sixteen months to June 11th, 2010 recorded marginal growth of +0.45% to close at N11.20 from N11.15 it closed at the end of January 2nd, 2009 trading session. This performance when juxtaposed with the realities of the overall market performance shows that the company’s stock is one of the least performing stocks on the NSE at this time.


The overall market performance measured by the ASI recorded -18.93% in the last sixteen months from 31.357.24 it closed on 2nd January, 2009 to close at 25,422.79 on the 11th June, 2010. The performance though in the positive of 0.45% was minute, when compared with appreciations recorded in some other stocks in the period, yet above the negative performance of the entire market (ASI). The stock closed far behind so many other stocks in the market.
 

In the year 2009 alone, the share price of the company closed with -35.61% depreciations, compared with -33.80% depreciations recorded in the entire market in the period. This negative performance indicates an overbearing influence of bears in the stocks, even beyond the overall negative market performance in the period.


A closer observation of the stock price trend showed that between August 14th 2009 when the crisis in the banking sector hit the market; NAHCo Plc’s share price shed a sizeable -23.62%; yet it was able to record a year to date appreciation of +55.99% from N7.18 it closed as at 4th January, 2010 to close at N11.20 on 11th June, 2010. This was above the +31% sector average appreciations for the same period, a ration impacted by the lower performance recorded by Air Service Plc. The trend indicates that NAHCo Avainace’s price movement places it as one of the top performing stocks both in the sector and the entire market, a reverse of the 2009 price trend recorded (as at this date).


THE ASI AND NAHCO PLC

The All-Share Index and Nahco Plc share price are moving almost in the same direction. In the year 2009 alone, the share price of the stock closed on -35.61% depreciation compared with the lower depreciation of -33.80% recorded in the entire market in the period. In the year 2010, Nacho Plc share price appreciated by +55.99% to outperform the market which recorded +22% appreciations for the All-Share Index.





As illustrated from the graph below, the NAHCo Plc share price now trades below its 20 days, 50 days moving averages which closed at N11.94 and N12.58 while it trades above its 200 day moving average of N9.17 as at 11th June, 2010. The stock resumed trading above its 200 day moving average on March 3rd, 2010 and has since maintained the trend to date.





Technically, with the NAHCo Plc shares trading above its 200 days moving average, a bullish outlook can be inferred, one that appears sustainable based on the forecast performance figures in section 4 of the report.



 
 


GENERAL COMMENTS AND OBSERVATION

Gross Earnings and Profitability: In the period under review, NAHCo Aviance notwithstanding the challenging operating environment recorded turnover growth of +36.95% to close at N6.067 billion compared with N4.430 billion recorded in the preceding comparable period. The company recorded higher profitability growth of +55.29% to close at N1.247 billion compared with N803 million recorded in the preceding period.


Close observation of the figures in the last six financial years showed that since the company recovered from the downturns in both the turnover and profitability of 2006 financial year, the trends in the two indices have been on the increase. There seems to be an overriding influence of turnover growth on the operating costs of the company which in way aided its ability to grow profit.


This is evident in the relationship between operating costs and turnover in the period under review; operating cost to turnover assumed declining trend in the last two financial years.





Operating Cost and Operating Profit Trend: In the last five financial years, Nigerian Aviation Handling Company Plc operating income growth has been at a higher rate above the operating expense trend, suggesting improved operational efficiency. The only year when the company recorded slack in operational efficiency was in 2006 when the growth in costs was above that of the income.





Financial Efficiency: The Company’s overall financial efficiency measured by cost to income ratio showed consistent improvement in the last six financial years as the cost to income continues to post declines to date. A company that is able to generate higher returns through reduced costs shows indications of more robust earnings to the investors. The impact of the company’s financial efficiency is also seen in the growth recorded in its earnings per shares in the year under review.

 



Investment in Assets: There was trend of consistent growth in the company’s assets in the last five financial years to date. However, close comparison of classes of assets showed that huge investment in the company’s assets were in the non-fixed (non-tangible assets). This in our opinion does not support the company’s claims of expansionary drive which we think should reflect more in huge investment in tangible assets.





VALUATION

Discounted Cash Flow (DCF) method of valuation is one of the valuation methods employed in arriving at NAHCo Aviance’s intrinsic value. Using a five-year scenario analysis with forecast free cash flows, we arrived at intrinsic value of N11.81 with Discount rate of 17% and terminal growth rate of 8%. Using the dividend discount valuation model, with projected dividend per share of 76k, we arrived at intrinsic value of N14.36.


PE ratio multiples valuation model generated an intrinsic value of N14.53 with our forward EPS and PE ratio of N1.12 and 13 respectively. In using this valuation method, our projected profit after tax of N1.375 billion arrived at was based on the view that the company will grow its returns in the remaining period in the year; otherwise our projected PAT would have been N1.17 billion due to the fact that the profitability trend recorded in the first quarter (2010) showed a downside.


Using EPS growth rate valuation method, we arrived at five year compounded annual EPS growth rate of 23% with projected EPS of N2.85 in five years time; this gives fair value of N21.26.


Therefore, combining the four valuation models gives average of N15.49. We are of the opinion that the share price of NAHCo Aviance under normal market condition should trade between N14.36 and N15.49. The use of multiple approaches to generate our fair value estimate helps us to avoid model bias and maintenance research which becomes more likely when one valuation approach is used to determine fair value of a firm.


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