Westwind research on Discovery Air

Our friends at Westwind Partners had Discovery Air around on an institutional investor roadshow last Friday. Here is what the research team had to report:

Discovery Air Inc. (DA.A-T: $1.37)
Rating: BUY Target: $2.25

Mkt. Cap: $179 MM ‘09 EV/EBITDA: 5.7x Total Annual Ret.: 64%

Management Presentations Increase our Excitement over Top Aces

Insight or Development:

Last Friday, we hosted investor meetings with DA management. The focus was on Top Aces [ed. note, a Wellington Financial Fund II portfolio co.], which appears to be a highly positive purchase. We have updated our model and have built in the impact of the Top Aces acquisition. Our EPS estimates for FY2008 and FY2009 have been revised upwards by $0.01; we may increase our estimates further once we have additional details. Our BUY rating and $2.25 target price are unchanged.

Analysis:

Top Aces currently operates eight modified Alpha Jets and four Westwind aircraft that provide training services to the Canadian Air Force. Management plans to expand this fleet by 10 aircraft – the entire inventory of Alpha jets available worldwide. This will cost about $1.4 MM per aircraft, including the necessary modifications. As a result, our capital expenditure estimates have been increased by $11 MM in FY2009 (eight additional alpha jets) and $3 MM in FY2010 (two additional alpha jets). While we have not yet modeled any incremental impact from these additional aircraft, we believe that these investments could position Top Aces to competitively bid for training contracts with other NATO allies.

Two benefits of this acquisition are: 1) it will generate revenue during the winter months when DA’s other businesses are slack; and 2) it will increase the percentage of Government revenue to 46%, thereby reducing DA’s reliance on the Northern Canadian resource economy.

Our FY2009 estimates for revenue and EBITDA have been increased to $160 MM and $50 MM (from $133 MM and $41 MM), as a result of the incremental impact of Top Aces. We have also increased our FY2008 estimates for revenue and EBITDA to $126 MM and $37 MM (from $115 MM and $33 MM), to account for a contribution from Top Aces from September to January.

Since Top Aces generates most of its revenue during Discovery Air’s traditional non-peak period from September to June, we expect less seasonal fluctuation from the overall portfolio going forward.

Given the long spring break-up and the busy summer, Air Tindi and GSHL seem to be doing well this year, benefiting from the increased summer activity in Northern Canada. While a slower forest fire season has impacted Hicks and Lawrence, especially in the second quarter, we are confident that any softness from H&L will be offset by stronger performance from Air Tindi and GSHL.

We have chosen to use conservative estimates for Top Aces. This acquisition could be a lot more profitable, thus providing upside from our forecasts. Following the release of the Business Acquisition Report, and the availability of further clarity especially with respect to Top Aces’ EBITDA margins, we will revisit our estimates. Further details should be released with the company’s Q2 results on September 13.

Conclusion:

Our DCF valuation and target price remain unchanged at this stage. However, there is likely further upside to our numbers once we obtain full financial details on Top Aces. We believe that the recent sell-off has created an attractive entry point for investors ahead of seasonal earnings strength. As a result, we reiterate our BUY rating on Discovery Air.

(All figures in C$, unless otherwise noted.)
John Grandy, (416) 815-3067 jgrandy@westwindpartners.ca ; Rahul Paul, (416) 815-3128 rpaul@westwindpartners.ca

MRM
(disclosure – Wellington Financial Fund II and certain managers/LPs own shares in DA.A as a result of the acquisition of Top Aces)