Dividend Detective: REX Holdings

Tuesday, October 17th, 2017

ASX code: REX
Share price: $1.51
Industry: Airlines
Forecast FY18 Distribution: 10c

Airlines are not typically synonymous with the type of companies one would expect an income-oriented investor to consider for their portfolio. However, proving there are exceptions to almost all rules in finance, Regional Express (ASX:REX) recently caught our attention after spending years grinding through an extremely tough operating environment, which claimed the scalps of many of its regional peers. High oil prices, a depressed fly-in-fly-out cycle and business-critical capital expenditures were the main antagonists for REX. Earlier this year, the Oracle of Omaha, Warren Buffett, came out publicly to justify his decision to dabble in a sector that was previously considered off-limits for value investors.

One of the main criticisms that is directed at airlines is the large amounts of capital expenditure required to simply stay in business. This includes expensive purchases of aircraft, property and plant purchases for maintaining its fleet and various parts and spares for its planes. When looking through REX’s capital expenditure in recent years, we can see that the company spent $50m in mid-2013 purchasing an entire spare parts package from a US airline, which future-proofed its fleet for 15 years. More recently, the company completed the acquisition of a warehouse near Sydney airport and a paint hanger in Wagga Wagga. Combined with its above average spend in the last two years on rotable assets (the bulk of which are aircraft parts), we believe free cash flow should pick up markedly in the coming years.

Oil prices are another tailwind for REX, with the company flying an extra 9 per cent of passengers compared to the previous financial year, yet spending roughly $5 million less on fuel. Jet fuel has typically been the largest single ongoing operational expense for airlines, often averaging between 25-35 per cent of total operating expenditure. With oil expected to remain under pricing pressure for the foreseeable future, combined with the relative lack of competition that REX faces on its routes, the company should be able to expand on its historical margins. Further to this, management pointed out in their last market update that the mining FIFO cycle appears to be firming, its new operations were up and running in Western Australia and enrolment numbers were up at its pilot academy, AAPA.

REX has announced it is set to pay a 10c fully franked dividend later this month, turning on the distribution taps for the first time in 5 years. On our analysis, the company is well placed to continue paying out significant, percent of overall, earnings as its capex requirements look to be substantially lower than recent years.

Trading at a decent discount to its NTA of $1.78 and with some strong tailwinds to likely guide profit materially higher this year, REX’s share price should be set for takeoff. As a small regional player, REX will inherently be susceptible to swings in rural economies and mining towns. However, we believe the undemanding multiple and potential for large dividend payouts coupled with a strengthening operating environment make REX an attractive investment at current prices for those income investors who can stomach a little more risk.

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