Sandstone Insights: Alliance Aviation surges on wet lease growth and robust FIFO contracts

ASX code: AQZ

Suggestion: Hold

Need to know

• Wet lease and contract flight hours jumped significantly to 135,000, mainly due to Qantas wet leases
• Fleet now 72 aircraft, mostly Fly-In Fly-Out (FIFO) work, growing to 90 by financial year 2026 (FY26)
• Seven major FIFO contracts renewed in FY24

Investment implications

Significant increase in flight hours

Alliance Aviation (AQZ) has experienced a significant increase in the hours flown on contract and wet leased aircraft. This increase took the company to 134,000 flight hours in the year, well ahead of the 75,000 reported in FY23. Company operated flight hours were 104,000, +39% on last year - the remaining hours were wet lease contracts.

The increase in wet lease hours flown for two customers pushed revenue from this source to $265.7 million and now represents 41% of group revenue.

Key customer relationships and FIFO contracts

Alliance Aviation's main customer is Qantas, which has wet leased 26 Embraer 190 (E190) aircraft from AQZ (wet lease includes aircraft and crew) and accounted for one third of AQZ’s revenue in FY24.

AQZ renewed seven major FIFO contracts throughout the year to bolster its contract flying hours, which represent 48% of total revenue. In contrast, Regular Public Transport (RPT) hours have fallen away to an immaterial amount. From AQZ’s perspective, fully contracted FIFO work is much more attractive.

Expanding fleet and financial health

The fleet now consists of 72 aircraft comprised of 24 Fokker 100 (F100), 13 Fokker 70 (F70), and 35 E190 aircraft. The E190 (94-114 seats) fleet will increase to 52 by FY26, taking the total fleet to 90 aircraft.

The balance sheet is well financed with net debt $336 million, placing net debt / earnings before interest, taxes, depreciation, and amortisation (EBITDA) at 1.9x. Capital expenditure (capex) of $115 million was related to the acquisition of E190 aircraft, engines and spares, and to fleet maintenance. The Rockhampton base facility was completed in FY24 and will be the maintenance facility for the Embraer fleet beginning October 2024. While capex easily outpaced net operating cash flow of $25 million, the majority was due to the increased activity of the company and will be cash generative very quickly.

Key financials for FY24

• Profit before tax (PBT): $86.3 million

• PBT growth: 65% year-on-year (YoY)

• Revenue: $637.2 million

• Revenue growth: 25% YoY

Positive outlook and strategic growth

Alliance Aviation sees continuing growth in contract and wet leasing activity with a further four wet leased E190s for Qantas on the way. While no financial forecasts were given, AQZ’s revenue and earnings are set for further meaningful growth over the next two years.

The network is based out of Brisbane and Perth with additional work based in Adelaide. With much of the work contracted to resources companies, AQZ has a dependable base on which to build its earnings.

Investment view

While Qantas (QAN) attempted to take over AQZ in 2022 (blocked by the Australian Competition and Consumer Commission (ACCC)), it currently has ~20% of the company and wet leases a significant proportion of AQZ’s capacity in regional Australia. The dependence on just a few major customers might ordinarily appear risky, but in AQZ’s case, this is a strong point.

The demise of Regional Express (Rex) and Bonza in 2024 casts no reflection on AQZ’s business model. Neither will the expected initial public offering (IPO) of Virgin Australia cause much change to AQZ’s network or competition.

Pathway to growth

The pathway to further growth for AQZ lies in delivering excellent service to its FIFO customer base and its three key customers who account for ~59% of group revenue.

The company has a relatively new and streamlined fleet with just three aircraft types. This will help to keep maintenance costs and operating costs under control.

On an FY25 price-to-earnings (PE) ratio of 6.1x, AQZ is in line with QAN. AQZ does not pay a dividend.

We see AQZ as a strong regional contract flight operator with solid credentials. Growth will be predominantly organic as the ACCC would be unlikely to allow any further acquisitions in the regional Australian air travel market.

Investment risks

The key risks are from contract renewal with its main customers. If replacement contracts are not signed, AQZ could be left with material excess capacity. Contract pricing also becomes important at renewal time.

Alliance Aviation's PE ratio chart

• _{The information provided by Sandstone Insights does not constitute investment advice and does not have regard to the specific needs of any person who may receive it. No warranty is given as to the accuracy or completeness of the information and any person acting on it does so entirely at their own risk.}