Special Free Report From The Motley Fool

By the Hidden Gems Canada Team

You’d be hard-pressed to find an investor who is unfamiliar with Amazon’s story of absolutely blistering growth, but you might not be familiar with the special relationship we’ve had with Amazon here at The Motley Fool…

You see, when The Motley Fool first recommended Amazon to its U.S. members in 1997, it was just a small-cap stock trading for roughly $1 a share… but many investors failed to take it seriously.

Fast-forward to today, Amazon’s stock is up a mind-boggling +32,000% – turning every $5,000 invested into roughly $1.6 MILLION!

Now, there are whisperings of a Canadian small-cap stock resembling that same early opportunity that Amazon presented… in fact, some analysts are even calling it “The Amazon of the North.”

Why Amazon, specifically? It recently secured a $600 million investment from none other than Amazon itself.

We were keen on this stock before this massive deal as evidenced by our official recommendation in late 2018, but this is a significant development to say the least.

Without further ado, allow us to introduce you to CargoJet.

To your wealth,

Your Hidden Gems Canada Team

CargoJet

Given I (Iain here) work from home, I get to see some things that otherwise might go without notice. One theme, shall we call it, that’s picked up steam since I began this gig is that, oh, about twice a week—more around holiday time and birthdays—at 9:30 am or so the doorbell rings (and the dog goes absolutely bananas). The reason: boxes. Boxes filled with stuff—stuff that somebody here, and it’s never me, has ordered from the internet. And while this theme has gathered steam, I don’t see it slowing down anytime soon. After all, who doesn’t need an endless stream of boxes filled with stuff?

If you’re familiar with this theme, even if you don’t get to see it first hand, it’s time you start benefitting beyond the stuff that’s being delivered. Indeed, this month’s recommendation is going to put you in the game, so to speak, and have you benefitting financially from a secular theme that’s really only begun. Buckle up and allow me to introduce you to Cargojet (TSX:CJT).

The Business

As you’ve probably gleaned by now, Cargojet plays a significant role in the delivery of stuff.

Founder and CEO Ajay Virmani began piecing together what would eventually become Cargojet way back in 1990. Back then, it’s unlikely he imagined the company that we have before us that operates a fleet of 21 cargo jets (see what I did there?) across three continents. The bulk of its business, though, is here in Canada. To reiterate, somewhat remarkably, the company controls approximately 95% of the domestic overnight cargo business with approximately 75% of its volumes covered by long-term contracts with solid customers—a list that includes the likes of Canada Post, UPS, and, yes, even the mighty Amazon.

Cargojet’s network, based in Hamilton, extends across 14 major Canadian cities, to which its planes fly in and out of each business night. Most customers pre-purchase a guaranteed space and weight allocation on the company’s network and a corresponding guaranteed daily revenue amount is paid for this space and weight allocation. Remaining capacity is sold on an adhoc basis to contract and non-contract customers.

Demand tends to be seasonal, peaking in the fourth quarter (I suppose in some ways, Cargojet is Santa Claus) but highly dependable when one considers a full calendar year.

There’s more to the business, however, than flying around boxes full of stuff from one end of the country to the other. Cargojet plays a key logistical role helping a number of international airlines connect to gateways to Canada. This helps to support lower demand legs and provides a revenue opportunity with little or no incremental cost, as the flights are operating on regular schedules. In addition, it provides dedicated aircraft to customers on an adhoc and scheduled basis typically in the daytime and on weekends. The adhoc charter business targets livestock shipments, military equipment, emergency relief supplies, and virtually any large shipment requiring immediate delivery across North America to the Caribbean and Europe. Need to send a cow to Texas? Cargojet has you covered.

There is also a growing international presence in the offing. The company operates a five-day-per-week cargo service between Newark, New Jersey, and Hamilton, Bermuda, that’s patterned after the Canadian business. In addition, a couple of years ago, the company commenced all cargo flights under contract between Canada and Colombia, Peru and Mexico, expanding this contract to include one flight per week between Canada and Frankfurt, Germany.

The Opportunity

With a dominant market share in hand, and growing need for the service it provides, at worst, Cargojet offers a very stable business. The story, however, gets much, MUCH more intriguing than that.

You see, things really got rolling for Cargojet back in 2014 when it entered an exclusive deal with Canada Post, which includes Purolator. In October 2017, the deal was extended through to March 2025, with options for further extension thereafter, potentially through 2030. This early extension prompted the company to bring forward its capital-expenditure plans a few years to upgrade and expand its fleet, which is sort of where we’re at today.

From here, we think that the growing e-commerce business in Canada and the potential implications for in-air cargo shipments it implies is going to provide a very lucrative tailwind for the newly upgraded fleet. A recent measure indicates roughly 6.5% of retail sales in Canada were of the e-commerce variety. This falls quite shy of e-commerce’s share in both the U.S. and U.K. at 8.3% and nearly 17%, respectively. Not only do we expect Canada to play catch-up, if the two-per-week doorbell ringing around here is any indication, that share is going up across the board.

When one utters the word e-commerce, one must include Amazon in the same breath. As recently as a couple of years ago, Amazon claimed to hold 7% of Canada’s e-commerce market. If it’s been anything like the U.S. lately, that share has probably risen. Already having a relationship with Amazon could be a significant win over the long term, while putting the recent fleet expansion to good use right now.

There’s also the growing international presence to consider. Indeed, the company’s CEO has bold ambitions to double the company’s size over the next five years, and the international segment is going to drive a significant portion of that growth. It’s unreasonable to believe Cargojet will garner even close to the market share it enjoys on its home turf, but it’s a big world out there. A mere fraction of the action will do quite nicely (read: make shareholders money).

Financials and Valuation

The story is a pretty easy one to digest, and there’s lots to like. Where the team stumbled, however, in our evaluation process was on the rather outsized capital expenditures Cargojet has made in 2018. It’s related to aforementioned fleet overhaul, but to move this company to the formal recommendation stage, we had to get comfortable that this was merely a short-term situation. Given you’re reading this, it’s safe to say our concerns were appeased.

About half of this year’s expenditures are related to aircraft growth (two conversions and one purchase). The other half is more maintenance oriented because three or four engine overhauls were pushed out from last year. Therefore, about half of this year’s $100 million or so in capital expenditures is a more reasonable figure to bake in for the years ahead … maybe less. We expect that with more capacity on the aircraft front driving revenues, and cash flows, Cargojet is going to become somewhat of a free cash machine in the years ahead.

That said, as with any great business you come across these days, shares aren’t cheap. The multiples at which Cargojet trade are rather lofty, but well worth paying for a company of this calibre with the prospects that we foresee.

Management

We alluded to founder and CEO Ajay Virmani earlier, but more detail is warranted. Not only does he own about 10% of the company (when share dilution from convertible debentures is considered), he’s clearly the company’s driving force.

One of Virmani’s first jobs in Canada when he arrived here from New Delhi, India, in 1975 was washing windows. In 1979, he began working as a customer service clerk at Cottrell Transport. In September 1995, after branching out on his own some years before, he bought Cottrell Transport. Cargojet was eventually launched in February 2002 from the ashes of Canada3000’s cargo division (I shudder when I consider a few Canada3000 flights of yore. It might as well all have been a cargo division).

Virmani is a true entrepreneur and someone we’re very keen to have in our corner.

Risks and Considerations

Given the upfront spending that launching a competitor from the tarmac would entail, it seems reasonable to assume that an upstart is unlikely to threaten Cargojet’s position in Canada. However, that doesn’t mean that one of Canada’s established passenger airlines couldn’t begin to encroach using spare capacity in their planes’ underbellies or converting older passenger planes into ones fit for cargo transport. Though, based on recent activity (like with Air Canada), it appears that they’d be more interested in partnering with Cargojet than competing directly with it.

Perhaps the most significant risk involves customer concentration. However, this is as much a function of being the only game in town as anything. Nevertheless, about 60% of the company’s sales involve just three customers (Canada Post, UPS, and TFI International) and though agreements are in place, should these not be re-upped, it’d be an unfortunate development.

The balance sheet has also been utilized to facilitate the fleet improvement that has occurred. Increased leverage is always a consideration but given the stability of the business and its potential, we can live with the financial risk that exists.

Valuation is also something that could deepen any slump that the stock experiences. Again, though, show us a company of this caliber these days and we’ll show you a rather full valuation. The way to navigate this dynamic is to potentially leave some room to add to any Cargojet position you initiate.

Foolish Bottom Line

Dominant business: check. Great prospects: check. Aligned leadership: check. And we’ve not even mentioned the dividend that’s grown nicely in past years—something we expect will continue as capital expenditures normalize. Here, Fools, is a company that you’re likely to see multiple times on the Hidden Gems Canada Scorecard in the years ahead. We suggest you follow our lead and pick up some Cargojet shares today!

For an even more recent look at CargoJet, check out our Best Buys Now alert from earlier this year.

Disclosure: John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. David Gardner owns shares of Amazon. The Motley Fool owns shares of Cargojet and Amazon. Report data as of October 5, 2018.