Thursday, August 10, 2017

ERA Group Pitching a Good Game

Asset prices in the US are pretty high at the moment, except for those related to oil and gas, which is one of the few depressed sectors. ERA Group (ERA) owns and operates helicopters that transport personnel to offshore oil platforms. That description is enough to turn off any mainstream investor who has read a newspaper in the last three years, which is what attracts me to the situation.

ERA trades at a 60% discount to book value, as revenues for offshore exploration and other oil and gas customer non-necessities have dried up. Impressively, however, the company has been able to generate cash as of late. On a market cap of $190 million, so far this year the company has generated $13 million in operating cash flow, while spending only $7 million in net equipment over the same period and with spending commitments going forward of only $5 million.

Business appears to be picking up as well, with management stating this week that, “For the first time in a long while, we are experiencing an increase in customer activity in our U.S. oil and gas operations, beginning in the third quarter of 2017, which is expected to result in higher utilization of the existing contracted fleet as well as additional helicopters being placed on contract."

I have no idea if this pick up will last past this quarter, but one doesn't have to count on it. Most of the company's debt is not due until 2021, though there is a $67 million payment due in 2019. Eventually, the oil and gas market will return, as wells are depleting at a faster rate than new ones are being found, thanks to the price. On that topic, I found this chart interesting:

ERA has been successful at reducing its assets as demand has slowed. Lighter helicopters in particular have alternate uses, which has allowed ERA and the rest of the industry to reduce capacity. Last quarter, the company generated gains of $5 million on asset sales.

It's worth noting that one class of helicopter that the company owns (with a book value of $156 million) was involved in a crash unrelated to the company. As such, all of these have been grounded for some time, and steps will need to be taken before the market regains confidence in these Airbus models. Even if one counts these at half of book, however, ERA still trades at a 50% discount to tangible book.

If you like this idea but find the equity too risky, you may instead be interested in the company's debt. The bonds trade at a yield of almost 11% despite some generous asset coverage. For me, the equity is too risky as a full position (commodity industry, commodity company etc), but works as part of a basket of similarly risky equities where the chance of loss for any one security is higher than I'd normally accept, but where the upside likely more than compensates for this risk in my estimation.

Disclosure: Author has a long position in shares of ERA


Dean said...

have you looked at HNZ in Canada. Similar story.

Igor said...

Do you happen to have a link where I could find some description of that graph? I'm a little confused why the level of inventories in the end of 2016 is not the level in the beginning of 2017.

Saj Karsan said...

Hi Dean, I just haven't seen HNZ turn the same cash flow and have the same discount, which has kept me on the sidelines.

Hi Igor, good observation. Here's where I got the chart from:

Patrick Petermeier said...

Hi, what do you think about Bristow Group? Patrick

Philbert said...

Senvest Capital owns Bristow Group. In fact they mention the company in their recent quarterly report.

Saj Karsan said...

I don't love Bristow's persistent negative cash flow and large debt situation.

That said, the whole space seems undervalued so if there's any pickup in the commodity price I'd expect all of them to do well.

Aly Mawji said...

This stock looks cheap...down to $11 from around $30. Price to tangible book about 52%

But then I look at the underlying business and it's so shitty. Over the last five years, every dollar of cash flows plus some has gone into capex to maintain the fleet. So there is no money leftover to pay dividends or repurchase shares. Essentially there is no owner income. And this capex isn't unusually high to support a growing business - revenue is essential flat over the period.

EPS is now negative and expected to be so for a few years.

What am I missing that you guys are seeing?

Saj Karsan said...

Hi Aly,

First, I don't think this one is as attractive as it was a couple of months ago thanks to a bit of a price rise.

Second, I agree with your analysis of the past, but I do see a different future. A lot of the capex commitments were made during boom times, which have since turned to bust. Going forward I expect capex to be significantly less than depreciation, and for the company to be able to generate cash as a result. This is already happening, so I expect this to continue and hopefully improve as the oil market supply/demand balance slowly returns to normal.

When that eventually happens, I would expect these assets (minus the ones impaired due to the safety concern) to then earn the company its cost of capital, at which point I would expect the market would value them at something closer to book value. Because a lot of these assets are not specific to the oil industry, however, I don't think a full oil recovery is necessary.

Things could still go wrong, though. I just like the odds here.

Aly Mawji said...

Thanks Saj...that does make sense, so you are saying they spent a lot of money and now have strong capacity to service needs in the future as demand picks up? I could see that but I don't know enough about it.

What about the bonds? Even with a not great business, they seem to have no problem covering interest payments from operating income/cash flow. Also the value of their assets (mainly helicopters) appears to provides a huge margin of safety. Tangible assets $822m. LT debt $230m. Did you say they trade at a ytm of 11%?

Aly Mawji said...

Just by way of update I called my broker to price the bonds. They said the price is 97.25 giving a YTM of 8.41%. However, price not by very accurate as not much trades.

On a related note, what is the easiest way of looking up bond prices? Do you have to have a paid service?

Saj Karsan said...

Hi Aly,

I agree with you about asset coverage on the bonds.

I use this site:

The price has gone up since my article but it seems pretty volatile for a bond, so can pick some up at a few percent discount to par.

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