Is it time to take another look at Aeroflot’s stock? That was the question posed by analysts at Aton on March 2, which upgraded the name from 'hold' to 'buy'. 

After several years of strong growth the company has gone off the boil as revenue growth slowed and staff costs rose. The company’s stock took off in the middle of 2015, climbing from a low of RUB34.85 set on June 9 that year to a peak of RUB213 on July 7, 2017, but has sold off again since then. The stock was trading at RUB150 as of March 2.

Hit by Kremlin imposed holiday bans to Turkey and Egypt, Aeroflot has not had an easy time of it in the last few years. The earnings per share (EPS) declined 44% in 2017 y/y and put pressure on the stock price. However, analysts at Aton believe that this year will be more successful. The company reported a slow start to 2018 with moderate January results on March 1 that met with a mixed reaction.

“Overall passenger turnover increased 7.5% y/y, mainly driven by domestic flights, which saw 8.6% y/y growth, while turnover on international flights was up 6.8% y/y. Passenger numbers increased at nearly the same paces. Seat load factor improved 0.7 pp to 77.3%, with a strong 3.4 pp pickup on domestic flights and a 1.1 pp decline on international flights,” Igor Vasilyev, an analyst with Sberbank CIB said in a note. 

“The reported numbers are below the company's guidance for the full year (9-10% y/y growth in passenger turnover), though they were weighed on by the high base of January 2017, when passenger turnover grew a very strong 19.3% y/y. In our view, the results are neutral for the stock, and the market will focus on the 2017 IFRS results, which will be published today, as well as the dividend payout,” Vasilyev added.

Amongst analyst’s key concerns in the short-term is the company’s cost control. The carrier has been struggling to hang on to pilots that are leaving Russia since the devaluation of the ruble for better paid jobs elsewhere. At the same time rising oil costs is driving up fuel costs. However, during a recent conference call management say they have these issues in hand.

“Management said it had begun to pass higher fuel costs on to customers during 4Q17 and expected yields to remain positive during 2018. Continuing cost pressure would come from fuel and staff, but marketing spend should fall, helping cost control, while deleveraging should support the bottom line. Fleet growth will be substantial this year (+31 planes) but moderate in subsequent years,” Mitch Mitchell, an analyst with BSC Global Markets said in a note.

Aeroflot has cut the plans to expand its fleet in the three subsidiaries Rossiya, Pobeda, and Avrora, Vedomosti daily reported on March 1 citing Aeroflot's reports. The company has cut the plans on expanding its feel by 16 jets (currently Aeroflot operate a fleet of 224 jets, with 187 Airbus and Boeing, 34 SSJ100, and another 107 jets at subsidiaries).

Despite the recent slow down in growth Aeroflot’s long-term story remains intact. The company will be one of the most obvious beneficiaries of the increase in income that is expected as this year wears on. Aton analysts were a lot more upbeat on the company’s prospects.

“Aeroflot reported healthy 2017/4Q17 IFRS numbers [on March 1]. Though they were in line with consensus, the stock rallied over 7%. The reason is that investors feared that the results might be well below market expectations due to a high oil price and rising staff expenses. However, management kept other costs under control, while yields stabilized after declining within 9M17, and this supported the company's earnings and margins,” Mikhail Ganelin of Aton said in a note.

Amongst the more attractive aspects of the name is the high dividend yield. Aeroflot’s dividend policy suggests a 25% dividend payout ratio under IFRS but analysts all expect it to comply with the government order to pay out 50%. According to management comments this week the current plan comes in at 7% under a 50% payout ratio.

“As a result, we believe all concerns about Aeroflot's earnings are behind it, and we expect the stock to return to investors' attention. The expectations of a new wave of EPS growth, stable dividends, and a low valuation prompt us to increase our target price to RUB200 (from RUB160) per share and upgrade our rating to Buy from Hold,” Aton’s Ganelin said in a note.

If Aeroflot were to pay the whole 50% then it should pay a RUB10.2 DPS for 2017, which implies a 7% yield. The board is expected to approve the dividends in May, which should become a trigger for the stock, say analysts.

“However, more importantly, dividends should increase in the coming years. We forecast 20% EPS growth for 2018, half of, which is likely to be spent on dividends. This implies over 8% yield and reinstates Aeroflot as a top dividend stock,” Sberbank said.

Aeroflot currently trades at a 2018E EV/EBITDAR of 4.9x and P/E of 6.3x, which implies a 30-40% discount to its global peers’ average. “This is a lot,” says Ganelin.

“On our estimates, Aeroflot is now one of the most undervalued airlines globally despite combining strong EPS growth with the highest dividends in the sector. We note that since our previous report in Dec 2017 Aeroflot has substantially underperformed the Bloomberg World Airlines Index,” Ganelin adds.

 

Aeroflot 2017 IFRS Review
Rb mn	2016	2017	% chg. y/y
Revenue	495,880	532,934	7%
EBITDA	78,004	56,015	-28%
EBITDAR	137,567	121,808	-11%
Net profit	38,826	23,060	-41%
Net income	37,443	22,872	-39%
EBITDA margin	15.7%	10.5%	-5.2ppt
EBITDAR margin	27.7%	22.9%	-4.9ppt
Net margin	7.6%	4.0%	-3.3ppt
Source: Aeroflot, Interfax, BCS GM