Boring Portfolio

Reviewing Atlas Air
... Keep it? Chuck it?

by Greg Markus (TMFBoring@aol.com)

ANN ARBOR, Mich. (Sept. 8, 1998) -- Today's Boring recap was written prior to the opening of trading on Tuesday, as I am traveling all day. As I write this, I thus have no way of knowing how the market or the Boring Portfolio fared on Tuesday. I do know, however, that McGwire (NL: CARD) gained 1 to close at 61 Monday and has a good shot at setting an all-time high later today.

As I indicated late last month, I've decided to rotate out of my duties as manager of the Boring Portfolio after almost three years on the job. As much as I've enjoyed and learned from the experience, I need a break from the daily deadlines. I won't be leaving Fooldom, however. Instead, my expectation is that I'll be able to focus, um, laser-like on providing in-depth, usable information about companies from the perspective of the individual investor after I'm untethered from the day-to-day responsibilities of running the Borefolio. My partner over the past year, Mark Weaver, will rotate out along with me.

The current plan is that a team from Fool HQ, Dale Wettlaufer (TMF Ralegh) and Alex Schay (TMF Nexus6), will assume Borefolio duties most likely on October 1. Dale and Alex are already well-known to readers of The Motley Fool Lunchtime and Evening news, and I'm sure that we'll all learn much from them here. (When they will find time to sleep is their problem.)

Undoubtedly, the first thing that Dale and Alex will want to do is to survey the current Boring holdings, deciding what to keep and what to replace to better reflect their own investment philosophy. Rest assured, however, that the Borefolio's emphasis will continue to be on what some consider to be basic, unglamorous companies and on searching for good value.

To assist Dale and Alex -- and also to remind ourselves -- Mark and I want to devote some time over the next couple of weeks to reviewing what we see as the relative risks and rewards of each of the eight Borefolio holdings. The idea is to focus not only on the potential upside for each company (and its stock) but also to point to what we see as some reasons why a given stock might not be everyone's cup of tea.

In all of this, as always, we invite your active participation. You can post a comment on the "Boring Stocks" board or on the stock board devoted to the particular company about which you have an opinion, either at the Foolish Website or on AOL.

I'll kick off the series by offering my opinion on Atlas Air (NYSE: CGO). The Borefolio purchased its 150 shares of Atlas back on March 5, 1997, and the original "buy" report outlines the reasons for doing so. But let's bring the story up to date.

Founded in 1992 by chairman, president and CEO Michael Chowdry, Atlas Air has grown rapidly to become the third largest air cargo carrier, measured in terms of cargo carried, behind only FedEx (NYSE: FDX) and privately-held UPS. Unlike those two giants, however, Atlas's customers aren't folks who ship packages. Instead, Atlas operates its fleet of Boeing (NYSE: BA) 747 freighters under long-term agreements with such international carriers as China Airlines, British Airways, KLM, and Cargolux.

Under so-called ACMI contracts, Atlas provides its customers with the aircraft, crew, maintenance, and insurance -- period. The customer, in turn, is responsible for all other operating expenses, including fuel, landing fees, and cargo and ground handling. In addition, the customer pays Atlas a guaranteed minimum rate regardless of cargo yields. Revenues and operating costs are denominated in U.S. dollars, thereby avoiding the currency fluctuation risks normally associated with conducting business abroad.

Why might an investor be attracted to Atlas?

First, consider the favorable industry trends. The globalization of trade and the increasing need for rapid delivery of everything from electronics to running shoes to flowers are long-term positives for the air freight business. Industry pundits project that global air freight revenues will grow at around a 7% annual rate well into the next century, and growth in traffic involving Asia -- where Atlas does the lion's share of its business -- is projected to grow significantly faster than that.

Second, Atlas is a young company, in its high-growth phase. It has grown far faster than the overall industry because it fits directly into the trend towards outsourcing: Atlas enables air carriers to increase their freight business without sinking capital into aircraft and hiring additional pilots. Atlas's proposition looks particularly attractive to passenger-oriented airlines as those carriers have shifted their fleets toward narrow-bodied, fuel-efficient planes that offer less cargo room in their bellies than wide-bodies do. Atlas makes a good profit because its customers assume the risks of short-term fluctuations in yields and because Atlas, in turn, outsources many of its own non-core functions. The company is basically planes, pilots, a skeleton crew at the home office in Golden, Colorado, and Mr. Chowdry, who owns roughly 60% of the company and spends two-thirds of his time on the road -- or, rather, up in the air -- meeting with customers and scouting for deals.

Third, Atlas's stock appears to be attractively priced -- particularly in the aftermath of the recent market meltdown. Based on guidance provided in Atlas's July conference call, analysts are looking for Atlas to earn $0.55 per share in the September quarter and $2.02 for the year, according to First Call. The latter number would constitute a whopping 84% improvement over 1997's $1.10.

As for 1999, the consensus estimate is for EPS of $2.74, or an increase of 36% over the consensus 1998 forecast. At its recent price of just over $22, CGO is thus trading at barely 11 times this year's EPS estimate and eight times the 1999 forecast. Historically, stocks of air freight companies trade at average multiples in the low teens. Using the historical multiple would suggest a near-term price target of around $40 -- a value that Atlas's stock in fact surpassed earlier this year.

Risks

The air cargo industry is heavily capital intensive, and as a young company, Atlas has borrowed heavily to finance its fleet expansion. As of June 1998, Atlas had long-term debts of $902 million and deferred aircraft obligations of another $296 million relative to total assets of $1.63 billion. Shareholder equity stood at a slim $253 million. Even with its hefty debt service, Atlas nonetheless generated $56.6 million in net cash from operations in the first half of 1998. Should business unexpectedly hit an air pocket, however, Atlas could find itself shouldering a world of debt and might conceivably find it necessary to sell some of its planes.

Atlas is literally in a global business. With that comes the opportunity to participate in the long-term projected growth of Pacific Rim and Latin American economies; but so, too, does it expose Atlas to the inevitable challenges those economies will face along the way. All indications are that the flow of exports from Asia is stronger than ever (due in part to weak currencies there), although shipments into that region are down noticeably. In the short run, Atlas is insulated through its long-term contracts from any consequences of such trade imbalances. Should the imbalances persist indefinitely, however, Atlas's customers would almost certainly push for lower rates when their contracts come up for renewal. Negotiations of new contracts as Atlas's additional capacity comes on stream this year and next could also be affected.

It's fair to say that Atlas Air's continuing success hinges critically on the talents of founder Michael Chowdry. Whenever a company's fate depends substantially on a single individual, risk is inherent. To find evidence of that one need only look back to 1996, when Chowdry turned over day-to-day operations to an executive brought in from Northwest Airlines (Nasdaq: NWAC). Atlas floundered after getting stuck on the short end of a deal to lease what turned out to be five problem-plagued freighters from FedEx. Those planes have since been returned to FedEx, and Chowdry fired the executive and reassumed control of the business. The tale remains an important cautionary lesson for potential investors, nonetheless.

The Bottom Line

Small, rapidly growing companies like Atlas Air almost always entail above-average risks. Atlas's international exposure and the capital-intensive nature of its business pose additional risks. Investing in CGO is thus suitable only for folks who can afford to have a portion of their portfolio exposed to potential turbulence. On the other hand, the upside scenario is not to be taken lightly, and the low P/E on the stock suggests that the risks are amply factored into the price. I'm comfortable holding the stock, but I can certainly understand why someone else might prefer something that flies a bit closer to the ground.

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09/08/98 Close

Stock  Change    Bid 
 ANDW  +1 7/8   15.00 
 CGO   +  9/16  22.75 
 BGP   +2 5/16  24.56 
 CSL   +1 3/4   39.25 
 CSCO  +5 3/8   94.63 
 FCH   +  1/16  21.44 
 PNR   +  5/16  30.56 
 TBY   -  3/16  6.31 
 
                   Day   Month    Year  History 
         BORING   +4.88%  10.24% -14.33%   7.80% 
         S&P:     +5.09%   6.89%   5.46%  64.64% 
         NASDAQ:  +6.02%  10.78%   5.76%  59.55% 
  
     Rec'd   #  Security     In At       Now    Change 
   6/26/96  150 Cisco Syst    35.93     94.63   163.34% 
   2/28/96  400 Borders Gr    11.26     24.56   118.21% 
   8/13/96  200 Carlisle C    26.32     39.25    49.10% 
    3/5/97  150 Atlas Air     23.06     22.75    -1.34% 
   4/14/98  100 Pentair       43.74     30.56   -30.13% 
   5/20/98  400 TCBY Enter    10.05      6.31   -37.16% 
   1/21/98  200 Andrew Cor    26.09     15.00   -42.51% 
   11/6/97  200 FelCor Sui    37.59     21.44   -42.97% 
  
     Rec'd   #  Security     In At     Value    Change 
   6/26/96  150 Cisco Syst  5389.99  14193.75  $8803.76 
   2/28/96  400 Borders Gr  4502.49   9825.00  $5322.51 
   8/13/96  200 Carlisle C  5264.99   7850.00  $2585.01 
    3/5/97  150 Atlas Air   3458.74   3412.50   -$46.24 
   4/14/98  100 Pentair     4374.25   3056.25 -$1318.00 
   5/20/98  400 TCBY Enter  4018.00   2525.00 -$1493.00 
   1/21/98  200 Andrew Cor  5218.00   3000.00 -$2218.00 
   11/6/97  200 FelCor Sui  7518.00   4287.50 -$3230.50 
  
                              CASH   $5750.59 
                             TOTAL  $53900.59