Aeroflot Airlines - Another Russian Stock With Asymmetric Risk/Reward Ratio

After discussing Gazprom some four weeks ago I'll be looking at Aeroflot today. It is another deeply discounted Russian stock with very promising long term risk/reward ratio. Aeroflot is the poster airline of Russia and has come onto investor's radars last year when Jim Rodgers mentioned the stock as one of his top picks for the Russian market. Let's have a quick look at the long term chart:

We had an impressive development from the early 2000s up until the financial crisis catapulting the stock price from well under 2 Euro up to 15. In a year's time the stock then lost all the gains from the previous years. It was trading close to 10 again in February last year before it started yet another dramatic decline down to 2.10. Before we look at what made that happen, apart from the obvious fact that Aeroflot is pretty much a bet on the Russian economy, let's get a quick overview of the company's financials over the last ten years:

Revenue, apart from the 2009 drop, rose steadily. Bottom line was positive all the time which is unusual to say the least for the industry and peaked in '07 and '11. Current market cap (at around 3 Euro per share) is $760 MM. You read that right, that's 8% of 2013's revenue for a company that operated profitable for the past 10 years at a net margin of close to 5% on average.

Why is Aeroflot successful in an industry that is known for loosing tons of money? The reason is Aeroflot has a somewhat monopolistic position in it's home market. Market share of domestic flights is 36%, on all air (domestic + foreign) travel 30%. Aeroflot's biggest shareholder is the Russian state (51%) which is obviously not at all interested in allowing too much competition for it's strategic businesses. I'd call that a moat in Buffet's sense that's unlikely to disappear all that soon. The first low cost carrier entered the market in late 2014 which has eroded margins in other parts of the world. In Aeroflot's case however this is rather regarded as a chance to service even more travelers than a threat as the new carrier was founded by themselves. This carrier will be operating from another Moscow airport (also serviced by Lufthansa for instance) to minimize cannibalization effects.

Those who think of Soviet style Tupolevs when they hear of Aeroflot will be surprised to hear that the Russians actually operate the youngest fleet (all Boeing and Airbus) of all carriers with 100+ jets in operation. And the margin is not thin as illustrated here (average fleet age in years):

Source

So what happened in 2014 to bring down their stock by more than 3/4?

• 12 month figures are yet to be announced (2. Mar) but 9M figures were red (less than $1 MM loss though!)
• This was partly due to a sharp drop in air travel to and from Ukraine
• With the massive Ruble drop revenue measured in US$ was cut in half!
• All the aircraft are leased on contracts in US$ 

Especially the last point is worrying as the fx situation can carry on for a long time or get even worse. Aeroflot makes more than half of their revenue on foreign routes and these will certainly be able to be repriced accordingly. However, it seems obvious that repricing domestic flights will lead to less travelers. Overall air travel in a country like Russia is certainly more volatile and dependent on economic development than in OECD countries. Lower oil prices should help but are settled in US$ which, at the current fx rates, doesn't really help lower cost for the domestic flights. These issues are certainly serious and have put an awful lot of pressure on the stock.

On the other hand you have to look at odds when investing. So in case Aeroflot is still around in a couple of years what will the business be worth? I've worked out an overview of some carriers and their current valuations:

5 and 10 years earnings are averages of the according periods, revenue is 2013's, all numbers in US$. I haven't even tried to calculate P/E ratios as there are so many loosing years. Only other carrier trading at less than 10% of their overall sales is Air France KLM which lost 5 billion dollar in the past 5 years, chapeau! Interestingly Aeroflot sports a higher equity ratio than all the other carriers apart from Singapore Airlines who are apparently very conservatively managed.

In a scenario where the fx situation normalizes and Russia makes a soft landing form the current crisis I reckon a valuation similar to pre-crisis levels is absolutely reasonable, in the long run easily more as air travel in Russia and the former Soviet states is expected to grow above industry growth. That would mean a stock price of 10 Euro or more compared to 3 Euro today. At 10 Euro Aeroflot would trade at a P/E ratio of around 11 when considering the earning power of the last 5 years. Another scenario is obviously a prolonged crisis and a very adverse business environment for Aeroflot. They managed the financial crisis quite well and have been profitable for at least 14 years in an extremely competitive industry so even if the situation around Russia gets a lot worse I don't really see them going belly up but there are substantial risks involved to say the least.

Overall however I think this is a buy. An opinion shared by Aeroflot's CEO Vitaly Saveliev who increased his stake in the company in December. Considering their very young fleet and extremely strong position in their market (manifested by solid profits for more than a decade) I will disregard my aversion for the air travel industry and pick up some stocks on weak days at around 2.75 Euro.

As with any investment ideas, do your own research and never buy anything because someone else thinks it's a great idea. 

Big Oil - Big Dividends?

Looking for solid dividend returns has become an increasingly tougher task with ever less major stocks returning north of a 3% dividend yield. The sliding oil price has however pushed major oil stocks to levels not seen for quite some time and thereby boosted their dividend yields to very attractive levels. With Friday's massive surge in oil prices and a temporary bottom of $45 a barrel this might be the time to look at Big Oil for dividend investors.

While the US runaway stock market leaves the investor with very little attrative options in the mother country of the shale oil that brought about this tremendous opportunity I'll focus this analysis on European companies that boost 5%+ dividend yields that are extremely hard to get by with comparable risks as I shall show.

First of all let's have a look at the seven major oil companies that are open to the dividend seeking investor. The following table has been compiled from several sources, mostly the companies' investor relations pages and Mornigstar:

What I'm looking for here is the dividend yield for the last ten years. I've calculated that yield with the average dividend payments for 2004 through 2013 and the current stock prices. While this is obviously no guarantee for likewise payments in the future it does give you a very good proxy for the dividend paying power of the corresponding stock.

Eni and Statoil both sport trailing dividend yields of more than 7% while the rest of the European pack comes in around 5%. Chevron and Exxon stop shy of 3% and "suffer" from their lower payout ratio which tends to be around 30% compared to their European counterparts' 50%.

Second ratio I look at is the trailing P/E (also referred to as Schiller P/E) which is a tremendous indicator for valuation and which stands at an absolute alarming 26.7 for the S&P500 as I write this. BP comes in first in this regard with Eni and Statoil following closely. While Chevron and Exxon are still very cheap with trailing P/Es of 10.1 and 10.4 they are again pricier than the most expensive European oil majors.

Three Favorites
So from a valuation perspective I'm most interested in Eni, Statoil and Total. BP does not compare too badly against them especially considering the ramifications from the Deep Water Horizon incident but then again they do show the by far lowest tax rate which might align with the average going forward. Royal Dutch Shell is certainly attractive from a balance sheet perspective but doesn't compare too well on the multiples. There is so much more to speak for or against these stocks but from a purely valuation oriented standpoint I feel most comfortable with these three.

Dependence on the oil price
In order to better understand the impact of the oil price itself on the earnings and dividend paying power let's have a look at the following table:

There are two major observations here. Firstly, there is only one data point which shows a loss (2010 Deep Water Horizon oil spill) which speaks volumes about the rock solid earnings power of the industry's leaders. Secondly there is certainly a correlation between profitability and oil prices but that's rather unpronounced in magnitude with oil prices between $40 and $110 and average net profitability between 5.7 and 9.2%. Here is the corresponding chart, oil prices are yearly averages of Brent oil:

I have no idea to what level oil prices might fall and at what prices any of these players might struggle to make decent profits but given the basic workings of finite resources I suppose that any price level that would severely impact the bottom line of Exxon and the like would be temporarily at most. The world needs incredible amounts of oil and refined products every single day and that is hardly going to change sometime soon. While there is plenty of money going for returns that provide more than just inflation compensation I think there will be a lot of demand especially for proven dividend aristocrats like Total, Statoil and Eni and to a somewhat lesser extent for BP, Royal Dutch Shell and the American oil majors.

The bottom line
Particularly Eni, Total and Statoil demonstrate rare opportunities to invest in industry leaders whose earnings proved to be resilient towards oil price volatility and who are at the same time trading at single digit P/Es. There is no reason to expect dividend cuts even with future oil prices substantially lower than the current $50. In case oil prices and valuations of the sector should revert to their long term averages we should see some pleasant appreciation in the stock quotes as well.


As with any investment ideas, do your own research and never buy anything because someone else thinks it's a great idea.