Motley Fool Hidden Gems Investing - The Sky’s The Limit

Episode Date: March 10, 2024

Sky Harbour sees massive opportunities in the world of private aviation. Bill Mann, Director of Small-Cap Research at The Motley Fool interviews Tal Keinan, CEO of Sky Harbour, a company that operates airplane hangars around the United States. They discuss: How Sky Harbour is building home bases for planes. The massive growth in private aviation and why it’s poised to continue. Turning underutilized airports into hubs. Companies discussed: SKYH, GD, BDRBF, FDX Host: Deidre Woollard Guests: Tal Keinan, Bill Mann Producer: Dylan Lewis Engineers: Kyle Carruthers, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

I think most chefs would tell you, go ahead and publish my recipe. It's all in the execution. Yeah. Right. So while there is no rocket science behind what we do, there is a lot more art than science in it. I'm Deidre Willard, and that's Tal Keenan, CEO of Sky Harbor, ticker SKYH. Sky Harbor develops, leases, and manages general aviation hangars across the United States,

focusing on airfields in large markets. The Motley Fool's director of small cap research, Bill Mann, sat down with Tal Keenan to explore the world of private aviation and Sky Harbor's plans for expansion. I've seen Sky Harbor described as a turnkey hangar builder. And to me, that kind of seems to miss the mark a little bit. So if you'll excuse the industry-related play on words, I was just wondering if you could give us like a 20,000-foot description of Sky Harbor's business.

Sure. So, look, we call ourselves a home-basing solution. So we're an infrastructure provider. We do build hangars. That's true. We manufacture. We're vertically integrated. But the end-to-end process is get land at airports, develop these campuses of private hangars, which are to be used as home bases versus an FBO.

We can get to that distinction. afterwards, and then operate them, right? So we don't sell them. We lease them on a long-term basis to credit tenants and operate them, meaning provide all of the line services that are required for conducting business aviation. So that's really what it is. And if you kind of want to think of it in aviation terms, if the FBO is a hotel for aircraft, Sky Harbor is a home for aircraft, right? Which is a distinction. We don't have a transient business. It's all based tenants. When you all came public two years ago, one of the things that you had spoken about was the supply-demand imbalances in the aviation industry. And so you've mentioned an infrastructure

deficit many times in the past. So for people who are not in the industry, could you talk a little bit about what the choke points are and what factors you view as being potential opportunities for businesses like Sky Harbor? So look, I don't know if anyone else measures this. We're probably the only ones because no one else really should care about this. But we track the square footage of the U.S. business aviation fleet, right?

Which is number of aircraft, times length, times wingspan. Of the fleet itself, you're not talking about ground space, you're talking about- The actual airplanes in the fleet, right? So they figure on the order of about 90,000 airplanes in the fleet. What's important for us to track is the net growth in the square footage of the U.S. business aviation fleet.

And I'll just kind of throw some numbers at you. In the 10 years that preceded COVID-19, we added about 30 million square feet net of airplanes, net meaning new entrants minus retirements, net 30 million square feet of airplane. that's accelerated dramatically and we don't have numbers post-covid but if you you kind of just go on any online resource you'll see the oems you know gulfstream bombardier deso textron are breaking records in in backlog right now you know some of these manufacturers you order a new airplane today you know it's it's a three or four year uh wait period until you actually take delivery of that of that aircraft so everything i'm saying for the 10 years before covid has accelerated dramatically since. A couple things to think about for our business, unlike the FBO

business, which is really driven by fuel revenues, we're really driven by what is the square footage of the fleet. Once an airplane gets manufactured, it needs to be housed, right? It doesn't necessarily need to be flown, but it needs to be housed. And if you take an extreme situation, you know, kind of a protracted, a deep economic recession, kind of doesn't matter so much to us whether the original purchaser owns the aircraft or the bank owns the aircraft, it still needs to be housed. There are a few areas where the supply-demand mismatch is most acute and where that mismatch is growing the fastest. The first of those is for large jets in that much of the current inventory of business aviation hangar in the United States has a door threshold height of 24 feet and down

because these hangars were built several decades ago when 24 feet was enough to accommodate the tallest tails in business aviation. So it turns out the growth in aircraft in that same 10-year period that I described earlier, the growth in aircraft that have a tail height of more than 24 feet is about 16.5 million square feet. So more than half of the growth in the fleet square footage is associated with aircraft that have that tall tail height. So those aircraft can't fit in those legacy hangars that's i'd say in terms of the type of aircraft that's where the supply demand mismatch is the most acute and where it's growing even more acute because if you look at the backlog of orders at the oems it's heavily weighted historically heavily weighted toward heavy jets

today and the second is you know the aircraft aren't delivered uh they're not spread evenly across the united states right there are specific areas where you know the fleet growth is the highest. Again, we track this very closely. I'm not aware of anyone else who really has any reason to track it, but that's obviously where our efforts are concentrated. That's where our company's growth is the highest, is where we see the supply-demand mismatch growing the most acute. Now, you've said twice now that you don't know of anybody who else is tracking it and don't know why they would. So maybe give us a little bit of an idea of where you sit in a competitive landscape not so much the installed base but is anybody else really focusing on what sound

it sounds to me like a problem that or an opportunity that uh might be apparent to a lot of players yeah i look i first i don't expect to be the only player in our space forever right we we will have you know and look we're you know we're posting our our numbers on a quarterly basis. People could see it. It's hard to think of something in the infrastructure or real estate space, for that matter, that is even close to this compelling on a unit economics basis. And the opportunity is deep. I mean, it's deep. It's hundreds of airports in the country that fit the bill for us. So I expect there will be others. For the time being, I haven't seen a national effort like what we're doing. I'd say the kind of the closest things, there's the FBO industry.

with which we overlap for sure. And could you, I'm sorry, could you, could you give a quick definition of FBO for those of us in the back of the room? The FBO is, is, is a fixed base operator, right? That is the entity that provides fuel and ground services to business aviation, right? And, and fuel is the main story there, right? It's, it's, it's, you know, kind of 70 to 85% of revenue. It's the essential service. The other stuff is nice catering. You can live without. Fuel is essential. So the FBO industry certainly overlaps with us. But I would say, if you look at it as a Venn diagram, it's maybe 10% overlap. We're not directly competing with those guys. And you do have one-off efforts to develop hangers that we've seen. Nothing like

what we're doing with a kind of a very well-capitalized national effort, vertically integrated, where we're constantly getting our cost of construction down. Our financing is really optimized for exactly this. Again, none of this is rocket science. It is a simple business, so I expect others will. But for the time being, we haven't seen it. Okay. Well, you actually anticipated a question that I was going to ask later on, but it's fascinating to me, especially with smaller cap companies, the decision to go public. Because in some ways, I'm always curious about an element of being a publicly reporting company, especially for a company that has a unique service offering. And as you say, it's not rocket science. You do

expect other entrants to come down the pike at some point. Are there parts of your business that you might otherwise like to keep confidential. But the fact that you're a publicly reporting company, you have to come out and talk about. I mean, in some ways, from a negotiating standpoint and from a competitive standpoint, that public reporting process might not be 100 percent comfortable. Yeah. So, look, I think there are obviously pluses and minuses to, you know, to every decision uh and this is one that we struggled with you know frankly i i don't i don't think it's a secret we turned down a one billion dollar private equity offer uh when we when we went public most days i would say we made the right decision um yeah in that right and look

there's there's a lot of again there are a lot of disadvantages uh i'll tell you how we handle some of those and and but what we see is the advantages as well fantastic the look publishing the recipe i think most chefs would tell you go ahead and publish my recipe it's all in the execution yeah right so while there is no rocket science behind what we do there is a lot more art than science in it. And say, for example, site acquisition, nobody goes out and solicits cities and counties directly on a serial basis like this for land at airports. That's not how the FBOs grow. The big FBO chains, Signature and Atlantic, grow primarily through M&A. That's their model. Much more efficient, they should. I think that's appropriate for them. But there is a

very deep bag of tricks involved. And how do you make this a win-win? How do you tick the boxes that need to be ticked? Remember, most airports are owned by local government. No two are alike. Everyone has their specific interests. How do you cater to those in the most effective way while still creating value for yourself? That's something that I don't think you're going to get reading our reports. And frankly, it'd be a challenge even to articulate it ourselves. It's a team that we've built. It's a set of methodologies. Some you employ in some circumstances, some in others. And we continue to refine that. And that's probably at the core of the value that we're creating here is that ability. also fusing it all together it it doesn't work nearly as well if you don't have the type of financing that we've arranged for ourselves if you don't manufacture your own hangers right and

you know save really significant margin on your you know on your construction the suite of services that you can offer is is quite different from what an fbo can offer and it you know takes a while i think to work that out as well so even i think a very well-funded competitor uh there is a a pretty protracted learning curve, we think, if you're going to compete directly. Again, I think it'll happen, and maybe we are offering a bit of a shortcut by being public, and you can read a lot of it, but I think most of the relevant stuff is not really there. On the other side, though, I think we have found a very efficient way to grow, because we're a very capital-hungry business. If you figure each airport is, let's say, $30 million to $60 million

of capital uh to to develop and they're coming in now at a very half very fast clip right we're you know we're pulling down airports every month now uh more or less raising a billion dollars in one shot would have been much more dilutive than what we've been doing which is going out again we're in the public eye we by the way and a lot of it is our tenant community uh you know who tend to be in many cases kind of the large sophisticated investors they see the model they understand it And it's our job to make maybe the rest of the market understand that we haven't quite done that yet, but our tenants certainly do. And we have a great overlap between tenants and shareholders, right? That community is wonderful.

And the fact that you're on a constant roadshow and people are following you makes it quite easy to dip into the market, whether it's a pipe or a different type of mechanism, and fund ourselves incrementally. And that's far less dilutive than, for example, taking billion-dollar checks. from private equity. I think that's probably been the main advantage of being public. I don't know if you just heard the sound, if my microphone just caught the sound, but from Cherry Point Air Station, they do low-altitude training with their F-15s, and one just flew overhead. I'm jealous. I am too, a little bit. I go ahead and wave at them. One of the things that you had mentioned was the concentration of the private fleet in the U.S. You are in the process of opening up in a number of different airports.

I was wondering if you could talk about what types of factors you look at that make an airport facility an ideal market for Sky Harbor. Great. All right. Well, look, fundamentally, it is that supply-demand mismatch. And it will be expressed typically in what we call total basing cost, right, which for us, and we have a formula that calculates the two main factors are what is a specific aircraft paying in rent and what is that same aircraft paying in a fuel margin? Those are the two main components of that. Um, and if we hit a certain threshold, you know, as you probably read, we're seeking double digit yield on cost, uh, in every project that we go into today for the time being, we're only targeting airports where if what people are currently paying will produce a

double digit yield on cost, that's, that's a valid airport for us. Now, there are other criteria, you know, like you don't want to build 500,000 square feet of hangar, you know, if that's going to cannibalize most of the market. You know, so there are size considerations, there are others, but the primary factor is what is the total basin cost today? Perhaps in the future, we'll get a little bit more speculative and say, look, here's an airport that's on a trajectory. I don't want to disparage anybody, but I'm thinking of a city right near where you're sitting right now, which if I had to bet five years from now, that city is going to be firing on all cylinders. It's going to be right at the heart of our envelope, but it's not quite there today. For the time being, we're not doing that, frankly, just because there's so much low-hanging fruit in the country that we should be grabbing right now.

And hopefully, we circle back and get to those markets afterwards. I want to make sure that I understand you properly, give you a chance to explain the definition of terms. You mentioned fuel margin rather than absolute cost of fuel. So again, for the layman, what does that mean? Yes. So the the FBOs and we we purchase fuel from the same suppliers that the FBOs will. You've got campuses that are on a pipeline. Right. So, for example, our Nashville International Campus is is on the colonial pipeline.

It means fuel gets there typically a little bit less expensively than to other airports. We will. Like the FBOs, we take a small margin on fuel. the FBOs take a large margin. It's their main business. But let's say the FBOs are pulling from a consortium in Nashville at, let's say, $4 a gallon. And if you could look, I could look it up right now, what their retail rates are for Jet A, they might be $7 a gallon, right? So they're capturing $3 of margin on that fuel. That's really what matters to us is it's not the $7 that the customer is paying, it's the $3 that the FBO is making. Call that available revenue from an aircraft or available net revenues, maybe the more precise way to express that.

So that's really what matters to us. Again, we reverse the order. By the way, in some cases, it's zero margin on fuel. All of our revenues come in the form of rent from the tenants. In some cases, it's some mix, but it's always heavily weighted. Call it 80%, 90% rent and a little bit of fuel margin. In some cases, that just, you know, kind of makes the deal easier with the tenant. Sounds a little bit like the old Jeff Bezos line, your margin is my opportunity. Yes. Yeah, that's good. I might start using that. I didn't come up with it, but I don't know if you've heard of Jeff Bezos. He's done okay for himself. I've heard of the guy, yeah.

So you're mentioning the types of airports that you're looking at. I assume that what you're talking about here is the home base for planes because they are in every way imaginable an asset that can move around the globe. Are there opportunities for a company like Sky Harbor in seasonal markets or destinational markets? I'm thinking of Vail, Colorado or an Aspen or Bar Harbor, those types of markets? Listen, great question. So far, we have not touched those. Maybe toward the end of the COVID episode, we looked because we saw people starting to enroll their kids in school in Aspen and Jackson Hole and places like that and thought, maybe these are becoming interesting home basing markets. We haven't really moved on that. I still

don't think they're deep enough to accommodate. Look, we're putting people on five, 10-year leases, 12 months a year. So those are great FBO markets. Aspen pumps fuel like crazy, great margins. It's great. They're not really Sky Harbor markets. The other side of the coin, though is you know we we announced our ground leases at the end of the last quarter our first two new york area airports are bradley connecticut and hudson valley new york those are terrible fbo markets right very few people are going to land in you know if you're visiting new york for meetings you know you don't want to land in hudson valley and uh and then drive i don't know you need another flight to get downtown yeah exactly so you land at teterboro that's that's really where you want

to be if you're visiting new york however it feels like every hedge fund in midtown manhattan has called us since that announcement you know we need space you know in bradley and those planes will reposition right most most of the manhattan owned aircraft that depart from teeterborough and arrive to teeterborough don't live at teeterborough they reposition uh you know in order so because there's no room there you can't you can't get hangar space at teeterborough so those guys are paying, even for those repositioning airports like Bradley, Connecticut, they're paying much higher rents than would in almost any market in the country for a primary airport, for an airport where the airplane lives at the same airport that it departs from and arrives to. So those aren't

great FBO markets, but they are great home-basing markets. So there's a kind of a natural shakeout in the industry. I was joking a little bit about you need a flight, but that's exactly the case, isn't it? There's a land in Teterboro and then reposition at Bradley. That's right. So a lot of people are doing that. By the way, some people fly to the airplane by helicopter. That's also kind of a big New York thing. Look, I watch Succession. I know how it works. Yeah. And look, for some of these big corporate flight departments, I get it. It makes sense. It absolutely makes sense. I mean, when time is money at that scale, at 100%, that is more of a necessity than it might seem. So maybe this is a bizarre question. I know that's got to be a great, you know, an alarm bell goes off in your mind when someone says, here's a bizarre question.

But I was trying – I was actually putting some thought into what other risks to private aviation there might be. And so you didn't name an entertainer, but I will. But it's one of the big cultural zeitgeist over the last 18 months or so has been the Taylor Swift tour. And she's come into some criticism for her dependence upon a private plane to get her point to point. Is there the risk of a drumbeat being loud enough that people begin to say, you know, identify away from having private aircraft? Yeah, look, so we've watched that. By the way, and it's a lot stronger in Europe than it is here, right? There definitely is an environmental movement that has taken issue with private aviation.

And they laugh at Davos when all those people come in and, you know, in their private jets, like, oh, you're here to save the planet. OK, so that's my point. In many cases, it's the same people who are using the system, which, you know, not to be cynical. Yeah, but I don't I don't think that movement has the sort of legs that's going to impair the industry. We're not I don't think we're shutting down business aviation, first of all, just kind of on a straight logical basis. There's about 100 things you want to target in the world. If climate change is your top agenda item, there's 100 things you want to get to before you actually get to this.

This is not something that's leaving a major mark. And again, the entrenched interests here are powerful. And so I don't see that happening, but certainly something we watch, of course. What can you tell me about your background? What led to your insight or your team's insight that there was this kind of market out there where Sky Harbor is doing something that is, at least on some levels, has no equal within the industry? Well, I had a plane and couldn't get hangar space, and this got me curious. And I spent a few years just with this as sort of a back-of-mind curiosity. It's kind of strange.

You've got this little market, not little, very large market that a lot of money flows through. How is it that the market hasn't solved this supply-demand mismatch? At first, I thought this was a New York area issue. Pretty quickly, it became clear it's most major metro centers in the country, to varying degrees, have this imbalance. And it's getting much worse. I used to run an asset management business called Clarity. We got professional management running Clarity. And I'd taken some time off to write and wanted to get back to work. And this curiosity kind of drew me in.

I come from military aviation originally, got a bunch of actual U.S. Navy pilots at the beginning. And that's still the core team. That's really who does the site acquisition. We got together and sort of figured this out. And lo and behold, you know, we wanted to go through the whole cycle before we got, you know, just kind of, you know, open the afterburners on the whole United States. uh but you know we're running three campuses now our numbers are coming in significantly better than we projected uh it works the unit economics work and now it's really become a question of scale yeah you want to continue you know to work on the unit economics if we can get our construction costs down you know by 20 30 a foot everything looks much better for sure but even if we don't we're we're in a really exciting position now it's you know can we get

to 50 airports? Can we get to 100 airports? If we're on 10 today, I think we gave guidance that we'd announce three more in the first half of this year. I think we're going to blow that out of the water. So that's really how we got here. I'm going to ask, you were talking about repositioning airports before. Do you see an opportunity? I'm always fascinated by Fred Smith and his model at FedEx, where he said, okay, we're going to be in Worthington, Ohio, and we're going to be in Memphis, these underutilized airports, is there a repositioning business whereby you are hangaring planes in an underutilized airport and then turn that basically into a Sky Harbor-driven facility in some ways? 100%. So that, for example, Hudson Valley,

New York is that. Bradley, Connecticut, to a great extent, is that. You have the Hartford insurance industry that uses Bradley as what we call a primary airport. Primary meaning the airplane lives at the same airport that it operates out of. But it's still mainly repositioning. Most of those Bradley aircraft are going to New York, some of them to Boston. That's where they're meeting their passengers and off they go. So yeah, that is a huge piece of our business, especially in, call it the top half dozen markets in the country, where there's really no room at the primary airport. There's no land. This repositioning market will increasingly claim a bigger stake of the home basing kind of pie in the United States. So yeah, that is big for us.

I've been invested in some of the Mexican airports for a long time. And one of the cliches about investing in an airport is that they're just not about to build another airport. But it may not actually be true in the private industry where you can simply reposition and and make the home airport something that's not necessarily convenient or even relevant to the end user. Yeah, so I would say, almost categorically, you can't build a new primary airport, right? That is true, right? Where there's land, there's no use for an airport. Where there's use for an airport, there's no land. And that's right. So it is beachfront property, 100%. It's a little bit less the case on the repositioning airports. But even there,

kind of look around you know again new york city is the densest business aviation environment in the country where is there even land for a repositioning airport right it's it's it's really all claimed now maybe out west there are a few places where that's a little bit different but but but in many markets there's no room for either yeah well talcane and this has been a fascinating conversation and thank you so much for coming and spending time with us here at the motley fool and i we're anxious to see where you all go from here we're really uh excited as well for that and thank you for the opportunity, Bill. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for

or against, so don't buy or sell stocks based solely on what you hear. I'm Deidre Willard. Thanks for listening. We'll see you tomorrow. Thank you.