Jaroslaw Kilian
Harbor Diversified (OTCPK:HRBR) is a regional aircraft operator with 64 CRJ-200 regional jets. Harbor Diversified had an operating contract (a capacity purchase agreement) with United Airlines that ends in March 2023. That contractual risk pressured the stock, but today they announced an agreement with American Airlines that should continue to utilize the majority of their fleet for another 5 years. Further details of the contract won’t come until the 10-Q is filed for the period ending September, but the news is likely positive for the stock.
Balance Sheet: ~ $2/Share
Starting with the balance sheet from the March 2022 10-Q, the company has $161.7M of cash and marketable securities. Then in addition there is a note bearing 4.5% interest that United is expected to pay when the contract ends next March of $51.1M for a total of $212.7M. This is offset by $80M of debt, promissory notes and operating lease liabilities for a value of $132.6M or $2.07/share (using 64.5M diluted shares).
That should provide a degree of downside protection because this is without the value of the American contract. The American contract at the very least keeps the company operating for another 5 years. Previously without the American contract it was necessary to consider liquidation values, but that seems less appropriate today in the presence of a new 5-year contract.
Three More Quarters Of ‘United’ Earnings: ~ $1/Share
Since we’re working off the March 2022 balance sheet, the company has another 4 quarters of earnings under the United contract. This has historically been noisy, but quarterly post-tax earnings in the range of $7M-$20M have been seen as the economy emerged from COVID. So we could see another $0.43/share to $1.24/share in value from the remainder of the United contract. Of course, as the contract ends there’s some risk that United are very focused on extracting all value possible from the contract and delay, miss or refuse certain payments, those issues would discount the above values.
New Contract With American: ~$2/share (Range $0.89-$4.40/share)
The details we have on the new contract are here. Further detail is expected with the next 10-Q. Although, HRBR has 64 aircraft the new contract is for 60 aircraft, and 40 aircraft at the outset. This appears a negative since American won’t use all of the current HRBR fleet even in the best case, there is an outside chance that United want to use some aircraft after March to manage the transition, but the contract does not appear worded to support two airlines. I read it as American will let Air Wisconsin ramp once initial thresholds are met.
It could also be that United has hubs in Dulles and O’Hare whereas American only cares about O’Hare, so the transitioning of pilots, crew etc. will take some months.
A final possibility, is that United come back and sign a contract for the 24 planes that American aren’t strictly obligated for and operate them from Dulles. Here is the relevant wording from the press release:
Air Wisconsin may also add up to 20 CRJ-200s as covered aircraft under the Agreement subject to satisfying certain minimum block hour utilization thresholds (resulting in an aggregate of up to 60 covered aircraft under the Agreement). Except as otherwise permitted in the Agreement, the aircraft covered by the Agreement may only be used by Air Wisconsin to provide regional airline services for American and may not be used by Air Wisconsin for any other purpose, including flight operations for any other airline. In addition, Air Wisconsin is subject to certain limitations on its ability to use aircraft not covered by the Agreement in certain passenger operations.
Here are a few ways to come at the contract value, all are speculative.
| Contract Value | Note | |
| Net asset value ($119M) | $91M | This assumes that the contract value covers remaining PP&E on the balance sheet (less another year of depreciation before the new contract). |
| Very good outcome | $284M | 93.75% utilization (60 aircraft) compared to prior contract, similar economics over 5 year 10% discount rate |
| Weak outcome | $58M | 62.5% utilization (40 aircraft) compared to prior contract, low end of former profitability over 5 years, 10% discount rate |
Clearly, all of the above are speculative. A simple average of the scenarios suggests $144M of contract value to HRBR. That’s $2.23/share with a broad range of $0.89-$4.40/share).
Conclusion
So, putting it together we have perhaps $5/share in value, with a range of $3.39/share to $7.71/share. How secure is that downside? Well, the liquid assets of $2.07/share feel solid, as some material earnings from the United contract over the period to March 2023, unless United really start to play games.
The American contract terms are far more speculative, but are likely to create far more value for shareholders than liquidation. On the one hand, the fleet is older than when the United contract was signed; on the other, this summer has been a nightmare for airlines and Air Wisconsin bringing capacity to the table may offer reasonable negotiating power. Also there is some evidence that Air Wisconsin is a strong operator, though it’s unclear whether they derive that value through the specifics of the United contract (a good deal that won’t repeat) or their own operational excellent (that could carry-over to an American contract). Finally HRBR was looking at liquidation without a new contract, so that created pressure.
Obviously, trading will be volatile over perhaps the next 12 months as news about the new contract filters out with the next 10-Q, the economics of the ending of the United contract are fully known with March 2023 reporting and the first results of the American contract are seen in June 2023 reporting.
Catalyst
The September quarter 10-Q should de-risk the shares by providing further insight on the American contract, which will likely reassure investors.
Risks
- Terms of the American contract are highly speculative, we really know nothing about the contract or economics at this point beyond it lasting 5 years and involving 40-60 aircraft and perhaps some new aircraft.
- Airlines have historically been a poor investment as times of overcapacity can destroy the industry economics.
- In a situation like this, return of capital to shareholders is key, as all the new contract may have done is kicked the can down the road until 2028 at which point the fleet is likely obsolete. If capital is squandered my management, shareholders will be hurt.
- Underlying earnings are volatile at the best of times, it is possible that HRBR loses money on either the future or legacy contracts, especially if rampant inflation persists.
- Trading is likely to be volatile over the coming months on newsflow and the stock is relatively illiquid
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