LON:AVAP | Avation PLC (LON:AVAP) - Aircraft Leasing

19th Feb '18 by Carcosa

18 comments 4661 reads

Hopefully my understanding of Avation (LON:AVAP) will assist anyone who may have a passing interest in aircraft leasing and prefer longer term investments...

Avation's 2017-2018 H1 results are due 26 February 2018. There will be Update Call at 1pm GMT on that day. For the Webcast you can register in advance or on the day. It will also be available for replay on their Website.

£AVAP are a small aircraft leasing company based in Singapore. They originally started out leasing old Fokker 100's in Australia but then graduated to becoming a major lessor for the highly successful and very much desirable ATR72 series aircraft. The ATR's are a turboprop aircraft for use on domestic and regional routes. The company then went on to lease the narrow-bodied A320's and A321's ; there first foray into modern jet powered aircraft. As most readers will perhaps know, these aircraft are primarily for short-medium haul operations. At the end of 2017, Avation entered the twin aisle/wide bodied market with a Boeing B777-300ER and Airbus A330-300. For Avation, a typical ATR72-600 costs $19.8m, An A321 $51.3m, a B777-300ER $152m and a two year old A330-300 is around $93m. These are actual costs and not list prices which will be considerably higher. The difference between list price and actual price is largely accounted for by who the customer is and how many aircraft are being ordered and likely to be ordered in the future. Very few airlines pay anything close to list price.

There are 10 listed independent aircraft leasing companies globally but Avation is the only listed aircraft lessor in the UK which is not ideal. I am ignoring Doric as they are a specialist fund manager with an innovative method of financing A380's.

The concept of aircraft leasing is quite simple. In practice airlines go to the aircraft manufacturer and place an order. Most of the time it takes 1-5 years before the aircraft manufacturer can start delivering the aircraft. The airline will pay a deposit but as the delivery time approaches they will (50% of the time) find a lessor and the airline will do a 'Sale and Leaseback' (SALB). Thus the lessor (in this case Avation plc) take ownership of the aircraft and agree to lease…

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rhomboid1

19th Feb '18

Thanks Caracosa , that was one of the v best user contributions ever here..a fascinating business, if dividend payments were at a higher level i’d be very interested as part of my HYP , as a growth share I need to understand the risks more ..specifically given their higher cost of capital how can they be competitive without taking a higher RV risk or covenant risk than the bigger players? Also I see regular block orders being placed on Airbus & Boeing by these bigger companies....so they have a bigger pipeline & i’d imagine a lower purchase price?

JohnEustace

The only point I would emphasise is that Avation (LON:AVAP) is a $US business. They trade and report in dollars but are UK quoted in GBP so UK investors need to keep in mind the exchange rate factor.

Carcosa

Hi rhomboid1,

I think you are right to consider residual value risk when assessing an aircraft lease company but I do believe the concerns are a bit overdone in the retail investment community

Any aircraft leasing company can be broadly summarised as operating one of three startegies: Having a young fleet, a yield focus fleet (older fleet in second/third life cycles) or a combination of both.

A young fleet has newer aircraft that are still in the first aircraft life-cycle and are thus less subject to residual value risk. Companies such as ICBC Leasing, Avolon, BOC Aviation, and Air Lease use this strategy and have average fleet ages of between 4 to 5 years. Top 10 lessors have an average fleet age of 7.4 years.

In Avation's case, from FY2015-17 to HY 2018 they have gone from 5.3, 4.2, 3.3 and 2.9 years respectively. On that basis RV risk is low; compared to their peers. Furthermore when you consider the aircraft types they have in the fleet, the demand for the aircraft, which would affect RV's, appears to be high. The ATR's are also highly valued compared to their purchase cost as evidenced by the 6 ATR sales above book value.

Another aspect is if Avation continue to provide widebodied aircraft to quality airlines then the acquisition cost will be below market value.

For the large quantity orders of which you refer the majority of such orders are made by the airlines. So, for example, the recent Vietjet A320 aircraft that were financed by Avation were part of a much larger total order by the airline. Whether Avation managed to obtain the same margins as the other aircraft supplied by the larger leasing companies is indeed questionable but certainly the aquisitoin cost should have been the same. However, the longer term benifit to investors is that these aircraft can be re-financed at a lower cost, should the possibility arise whereas the larger leasing companies may have achieved the lower cost of capital from day one.

As we are talking credit ratings:
Avation: B+ (Standard & Poor, Fitch); BB (Egan Jones, JCR)
Avalon (a reasonable comparator of young fleet aircraft but with 908 aircraft):
BB (Fitch) Ba3 (S&P) BB+ (S&P) See this Wiki link containing a table of credit ratings ranking

JohnEustace... absolutely correct as I alluded to in my initial post. The only saving grace is that their entire business is US$ denominated.

Thx for the excellent response, to take your example Vietjet ..they’ll have access to a number of lessors..one assumes they’ll take the cheapest lease cost, if the aircraft costs the same but Aviation has a higher cost of funds than the largest lessors then how can it win the business except by taking a lower margin, or tweaking the RV up a touch? Neither of those alternatives would be leave me particularly comfortable?

rhomboid1, I agree they take lower margin (25-50bps perhaps) but the RV will be the same for all lessors as depreciation charges are industry standard. Hence if Avation can refinance then that's a boost to company profits. Vietjet took three aircraft lessors for their A320 fleet.

In response to ridavies post on the SCVR:

The team has expanded considerably in recent times. Last reported figures are 20 people in total but now they have had further staff although I forget by how many (25+?). That should be good for a few years to come!

Jeff Chatfield is indeed a driven man and to see him 'walking' would be a huge surprise. If he does then I may be happy as I can only see the reason being a take over of around 320p plus! Now the company is gaining a foothold in the market and relationships are being forged by his team then his day to day influence decreases. Maybe.

Three are some institutional investors.

From the last AR:
Goldman Sachs Securities (Nominees) Limited 26.72%
State Street Nominees Limited 9.52%
Chase Nominees Limited 9.28%
Lynchwood Nominees Limited 8.61%
HSBC Global Custody Nominee (UK) Limited 6.18%

There is a problem though, the company really has to be well over GBP100m before institutional investors can look at the company.

Andrew L

A very low ROCE business with considerable debt. They haven't appeared to be able to reduce their financing costs despite the expansion.

simoan

This is the wrong way to look at the fundamentals. Avation (LON:AVAP) is never going to look great on the standard valuation metrics used by Stockopedia. It's basically an asset play, like the property REITS - so lots of debt and low ROCE but high operating margins. Main thing that concerns me is the constant negative free cashflow. I don't like investments that never seem to generate cash...

All the best, Si

ISAallowance

Yes, based on the stockreport, cumulative negative free cashflow over the last 6 years of $14.37 per share has produced an increase in book value of $1.68 per share, for a business valued at approx 1x book.

That doesn't seem like the best investment proposition to me, unless I'm missing something, which is always possible.

simoan - I don't think this is an asset play. How can it be with an asset that is depreciating in value? The underlying business is not to increase the value of the assets it is to generate earnings. An asset play would be a real estate company.

High operating margins - Not sure how this is relevant? What investors want is a high ROCE with the operating margin only one side of that. The capital intensity (capital turnover) also determines the ROCE. Operating profit is before the interest cost.

Avation will probably do ok but people should be aware that this is a business using considerable financial leverage to bolster its returns to equity investors. The underlying business has a low ROCE. That is a disadvantage. You can't really spin a low ROCE as it is a negative. For a real estate company the value of the assets may increase but this isn't the case here. After 30 years the aircraft are of little use.

...

Avation will probably do ok but people should be aware that this is a business using considerable financial leverage to bolster its returns to equity investors. The underlying business has a low ROCE. That is a disadvantage. You can't really spin a low ROCE as it is a negative. For a real estate company the value of the assets may increase but this isn't the case here. After 30 years the aircraft are of little use.

Well, I view it as an asset play. It's maybe a slightly simplistic way of viewing things but in reality the assets never depreciate as the company trades aircraft in the way a real estate company may trade properties. Are you saying property values only ever go up? this is why the age of the aircraft is so important as Carcosa has explained.

The share price definitely reacts to the NTAV of the aircraft as witnessed by the step up when a real valuation was put on the ATR fleet that was sold off last year. So the market pretty much agrees. Even more than that, the share price is affected by the value of the options for new ATR aircraft that Avation hold. It's not a manufacturer of widgets and so ROCE is a pretty meaningless metric IMHO. If you only invest in high ROCE companies you'll never invest in certain sectors e.g. property, financials, insurance etc. That's just the way it is but it doesn't necessarily make these sectors bad investments.

mojomogoz

Its a to infinity and beyond business.

Simoan - as it grows it will be cash flow negative ex financing. When it stops growing it should turn cash flow positive.

Great note by Carcosa! I can't invest in a business like this as I am not smart enough to assess it out 25 years nor cute enough to spot when to trade out on stock specific rather than systemic reason. IMO this is a business that has a short volatility like business model. Steady until its not and then can be rather damaged quickly. its basically a flow arbitrage on differentials between financing costs and cash flows. Their are company specific risks to the business (making a mistake). They are probably quite avoidable. But there is a shared systemic risk across the whole aircraft space (manufacturers, operators, leasers, etc) that is hard to assess.

In maturity it may be possible for me to invest as will have considerably higher dividend and perhaps some opportunistic controversies around terminal values and longevity of some assets to take advantage of. But probably not, as I still wont be good enough to see it (or informed enough in the space).

More systemic crises are feared than happen...so there may be a chance to buy during one of the false starts

Ciao

We could argue this all day. But low ROCE businesses are low quality business. It is the very definition of a low quality business. They may not be bad investments if they leverage up to increase returns to equity investors. However, they may be bad investments if the extra leverage results in a significant loss of value at some point.

Your argument is essentially that a low ROCE business can leverage up and generate strong long-term returns to equity investors. To do this it needs to have a relatively low risk underlying business. Avation might qualify but I don't think property, financials, insurance qualify.

Low quality businesses have to use significant leverage to attract investors. Hence the leverage is an indicator that the underlying business is fairly poor.

Your argument is essentially that a low ROCE business can leverage up and generate strong long-term returns to equity investors.

Well, I'm not arguing! I'm merely stating my opinion that ROCE is not a great metric to use for valuing some types of business, and I would suggest aircraft leasing, amongst a few others, is one such sector. That is all. If you use high ROCE as a requirement to make all your investing decisions I hope you can see there will be some sectors in which you will never invest. Perhaps they are low quality sectors, in which case you can just avoid them altogether like Terry Smith would. Other people may not apply a valuation based on ROCE in the way that you do, and that's fine - that's what makes a market!

ROCE is not a valuation metric it is a quality metric. Yes there are some sectors I wouldn't invest in because of a low ROCE. It is not a case of ROCE based valuation it is a case of using ROCE to assess quality and then figuring what valuation multiple you might pay on the basis of that. You don't directly assess ROCE against valuation. You assess earnings/cashflow against valuation.

If you don't assess quality then surely you are missing something? If you don't use ROCE to assess quality then what do you use?

smatthews1

20th Feb '18

Really excellent write up with avation, I have held these for a few years and been temped along the way to sell. Which I nearly did when they were announcing the sale of their atr's. However they only sold half were quick to recycle the cash into long haul jets. Seems a smart move and a good use of cash. With global interest rates still low and high demand with their jets and options, it doesn't look overpriced, I really can't find a good enough reason to sell them yet.

matylda

I hold Avation (LON:AVAP) but just want to mention, for what it's worth, ROCE...

For me I like to look at ROCE vs Industry and Op Margin vs Industry too. I use them as basic quality measures of the business/management/products. Simple yes, but works for me but only when compared against Industry peers. Sure, its not infallible by a long stretch of the imagination, just a quick quality check for me.

Nice discussion.

Nicowilson

Hi Caracosa

Well done. This is an excellent article. It's probably one of the clearest pieces of writing that i've read in a long time.

Thank you.

Nico

Avation PLC (LON:AVAP) - Aircraft Leasing

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Carcosa

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