28 May 2019
PTB’s primary business is the maintenance, repair and overhaul (MRO) of PT6 turboprop aircraft engines. The company has enjoyed strong growth in recent years and after increasing by 38% over the past three years, operating profit jumped by 37% in the FY-H1 of 2018 from a year earlier. I recently caught up with CEO, Stephen Smith.
|Date of Report||ASX||Price||Price Target||Analyst Recommendation|
|Date of Report 20/02/19||ASX ST1|
|Price $0.058||Price Target N/A|
|Analyst Recommendation N/A|
|Sector: Aerospace||52-Week Range: $0.515 - 0.74|
|Industry: Aerospace & Defense||Market Cap: $47.72 million|
What do you do?
The PT6 engine has been in production by Pratt and Whitney since the early 1960’s. This turboprop engine, which has been continuously upgraded and enhanced, is the mainstay of the general aviation industry and is widely used in regional, commuter and agricultural aircrafts.
PTB operates a number of business units that ultimately drive maintenance, repair and full overhaul work through the company’s facilities. The largest business unit is Pacific Turbine Brisbane which operates a major service facility near Brisbane Airport. Other business units include Pacific Turbine USA, which buys used engines and spare parts and manages MRO for clients through third party facilities, Pacific Turbine Leasing, which owns aircrafts on lease to operators, and Sydney based International Air Parts, which trades jet engine and airframe parts.
The key value driver is the ability to efficiently acquire and manage its inventory of spare parts. Accordingly, each of the business units is a key element in ensuring that the company controls demand as tightly as possible. MRO agreements are typically for five years and are structured on a programmed model with regular monthly payments. The leasing business will generate a “banker’s” margin but is primarily designed to lock in MRO agreements through the long term supply of aircrafts. The US operation is designed to leverage existing industry service capacity to manage some of the MRO agreements with the company managing the supply of spare parts.
PTB has carved out a niche providing a high level of service and support to smaller aircraft operators who would otherwise be “second order” clients of the major MRO organisations. The company manages over 150 engines under MRO agreements with a diverse client base of regional, commuter and agricultural airline operators mostly located in the Indian and Pacific Islands although some are also located in New Zealand, The Philippines and the US as well as in Australia.
What is the business case?
Over 50,000 PT6 engines and its variants have been produced by Pratt and Whitney over the past 50 or so years of which the company estimates maybe 40,000 are still in operation. Pratt and Whitney have a small authorised global network of dealers and MRO suppliers, however, there is also a larger network of “gray” suppliers, including PTB, who also operate MRO facilities. Although they are not authorised by Pratt & Whitney, they are nonetheless highly regulated by aviation authorities and must be certified to the same level as if they were authorised. The main limitation is that they do not have access to new spare parts on the same favourable terms. However, there is a deep market for used and reconditioned parts, which is also highly regulated, and these “gray” businesses typically operate in this segment. Engines can and are rebuilt many times to original specifications and are certified for regular use. Accordingly, the MRO market for the PT6 engine is deep.
What are the growth opportunities?
The company’s growth profile is largely based on building volume. The two key elements in accelerating growth are the leasing and US business units. PTB has a funding relationship with a Japanese group which has the potential to enable the company to build a sizeable fleet over the medium to long term, with guaranteed MRO agreements attached. The US operation, which only operates a parts buying and warehouse facility, enables the company to access existing service capacity without having to invest large sum in its own facilities. Moreover, it relieves bottlenecks in the Australian business where the ability to scale is constrained by the availability of skilled tradespeople.
PTB achieved a 37% increase in operating profit, to $4.4 million in the six months up to 31 December 2018 compared with the same period in the prior year from a 26% increase in revenue. The gain was spread across all divisions although the smaller divisions achieved outsized gains as that they built scale and achieved significant lifts in activity off relatively low bases. The US business in particular broke through to a maiden profit contribution.
A key feature of the business is that all MRO contracts are written in USD and most parts are bought in USD. Accordingly, the AUD share of the cost base is relatively low. Whilst this matching of revenue and costs in USD mitigates most of the currency risk, foreign exchange gains or losses are a volatile element of the income statement. The currency impact on the 2019 interim result was a small profit compared with a small loss in the prior year result.
Whilst the fixed asset base is significant, receivables and inventories comprise nearly two-thirds of the total asset base of $79.7 million. Debt levels are relatively low at $16.8 million, 21% of total assets, and partially offset by cash balances of $4.2 million.
The company has recently announced a final fully franked dividend of 7.0 cents per share having paid a steady 5.0 cents per share, fully franked final dividend in each of the past four years.
What do I think?
In an investment market that’s increasingly dominated by technology, services and financial companies, PTB stands out as a well-managed industrial concern with strong profit growth over the past three years underpinned by a solid balance sheet.
I like that it is a globally competitive business with multiple strategies to drive growth around its central underlying capabilities. With strategies designed to lock in long term MRO contracts and with recurring income contributing about 80% of total revenue there seems to be few income side-risks. Most risk seems to be related to the trading side of the business and the ability to buy parts at the best prices and management of the inventory, both of which are core capabilities of the company.
Barriers to entry are high and the market is deep and relatively mature meaning that the competitive environment is relatively stable. This should mean there are few surprises on the horizon and that the company should be able to continue to deliver solid growth and sound investment returns.
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