I have spent much of my career looking for strong macro trends that will drive the performance of individual companies. However, over the past few years, I’ve had much more success buying overreactions to bad news, as the makeup of the market has changed and short-term thinking pervades investment decisions. Often, large fund holders sell without even understanding what the news means. Instead, they’re more concerned with showing their investors that they didn’t own a stock that’s down 80%–especially if it’s a well-known company amongst their investor base. Meanwhile, when in sell mode, future bad news is all colored bad and good news is ignored—then the indexes kick you out and more selling comes on top. It’s just a pile-on. On the flip-side, the move from down 80% to even just down 60% is a doubling of the share price and it often happens rapidly when the selling ends. With that in mind, I might as well tell you why I own so much Aimia Inc (AIM – Canada).
Aimia operates and owns loyalty programs. It’s a reasonably good business, in that their partners buy points that Aimia creates. Aimia then give those points to their loyalty members and then at some later date, those members redeem the points for rewards such as free travel or gift cards. In the interim, Aimia has “float” from the cash that’s been paid for points that have yet to be redeemed. Additionally, a healthy percentage of points are never redeemed and Aimia gets to keep that “breakage” as free profit. Over the last few years, the sector has gotten rather saturated, which has somewhat reduced the value of individual programs, but it’s still a good business—even if it is one that’s in slow decline.
In any case, I’m not so fixated on the long-term business fundamentals, as I am on the reason that shares of Aimia declined 80% last month. On May 11, Aimia was notified by Air Canada that they would not be renewing their current relationship after it expires in 2020. Canadians, assumed that this was the end of Aimia as Aeroplan is the largest loyalty program managed by Aimia and Aeroplan with its 5 million members, ranks up there with Tim Hortons and maple syrup in the Canadian psyche. As Aeroplan was itself a spin-out from Air Canada, it was assumed by most Canadians that Air Canada was the entirety of Aimia. What these panicked shareholders have failed to understand is that Air Canada represents approximately 11% of the total points purchased at Aimia and while it is the largest redemption partner for points (loyalty members prefer airfare to other options), this spending power can be re-directed in other places where current and future redemption partners are desperate for the $600 to 700 million in spend that comes from Aeroplan. Even more ridiculously, this change with Air Canada doesn’t occur for three years. During that time, Aeroplan will earn enough to pay off all of its debt and dividend almost the entire market cap out in dividends. In fact, the company is going ex-dividend for the first of those quarterly dividends, representing 10% of the share price on Wednesday the 14th.
A lot will happen between today and June 2020 when Air Canada parts ways with Aeroplan. I think it’s likely that longer term, this is good news for Aeroplan (despite what you read in the financial press) as it diversifies Aeroplan redemption options and allows Aeroplan to direct redemptions towards higher margin options. In any case, it’s highly unlikely that I’ll still own the shares as this all plays out. For me, this is a short-term sort of trade where I’m looking for a bounce from a ridiculously oversold condition.
The shares trade at 1.5x current year’s cash-flow guidance and a 40% dividend yield. While there is always risk to any business—especially one in transition, this business has many other components that are doing well. Aimia has huge value in its half ownership of AeroMexico’s PLM program (likely worth about the same as the current enterprise value), along with many existing point purchasing partners for Aeroplan. I expect that point purchases will decline and redemptions will increase over the next three years as loyalty members leave the Aeroplan network. It seems likely that current guidance of $220 million in cash flow is unrealistic, but the magnitude of the miss is hard to guess at. My hunch is that the miss isn’t all that substantial, but without new guidance, it’s just easier for everyone to sell, rather than think it all through.
Basically, I don’t understand how a change that takes place in 3 years, should yield a company with a $300 million market cap if there is $556 million in cash and liquid investments, with only $450 million in debt, while the company will earn $220 million (guidance) for the next 3 years. Even if they miss the number badly, there’s still a huge margin of safety here. That is before considering the other programs outside of Aeroplan that are likely worth more than the entire enterprise value. There has been talk in the media of an increase in redemptions hitting liquidity—I’m sure that’s happening to some extent and the redemption liability is a true liability, but the increased pace of redemptions is not enough to impair the company. In summary, in a situation with limited transparency in earnings over the next few years, along with a change-over in the C-suite, most investors have chosen to sell—rather than actually evaluate the situation. Aimia is simply cheap and you get paid 40% a year to wait for others to realize this fact.
Disclosure: Funds that I manage are long Aimia (AIM – Canada)