LON:DNA3 | Doric Nimrod Three - A Good Risk/reward?

26th Jul '21 by shamusj

9 comments 829 reads

I spotted these shares mentioned in a popular broadsheet and looked into it further.

They are paying a 20% yield which looks too good to be true.

A summary of the investment is in their quarterly update (the link provided below from last month - June 17th 2021).

The investment is essentially a bet on a three things:

1) That Emirates airlines remain a going concern

2) They don't renegotiate the terms

3) The trust can sell the 4 Airbus A380's for a reasonable amount at the end of the tenure. All proceeds are returned to shareholders.

Regarding my thoughts on the above:

Point 1) - Emirates is essentially state backed by the Dubai authorities and is effectively their national carrier. They have already provided cash support and in my view are unlikely to let it fail.

Point 2) - No requests for any renegotiation has been received by the trust to date. It seems that the closer we get to the end of the year, with vaccination rates as they are, the less likely that will be.

Point 3)- According the their last quarterly update in June (LSE link here), they have use three independent aircraft valuers to predict the sale price of the aircraft at the end of the Emirate tenure and applied various markdowns from the worst case of 75% to 25%. I assume this is where the biggest risk may lie but even in the worst case of a 75% markdown to the sale price, the total return of this investment (so including all quarterly dividends payments for the next 4 years) is 59p. The 50% markdown of the valuation estimates gives a total return of: 75p which is 63% return on today's prices.

I took a small position as I don't know much about A380 values apart from what I read in the Economist (i.e. don't expect more than 30% of their original price, but I believe this has been factored in).

Has anyone looked into this or have experience of any other similar vehicle, I'd be interested to know your thoughts.

All the best,

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ls2g08

26th Jul '21

I have held DNA3 since inception, which wasn't such a good bet at the time and averaged down aggressively in March-April last year, as the current price seems very low, however it is quite high risk.

I see it as almost a free roll (minus opportunity cost) on the value of the planes at the end of the lease, as the cumulative dividends expected are nearly the same value as the current co's value. The risk of these dividends not being received is fairly small I feel as you have described above.

I have seen valuations of $24m per plane from investors I respect, which when including the payments due to the holders, value the company at circa 35p + 37p. Then any surplus cash in the company will also be returned to investors, which gives you another 5p per plane, so rough valuation of 77p. My feeling is the terminal value will be somewhere between 21p-35p.

More scuttlebutt I have heard is that Emirates will use DNA 1 & 2 planes for training and DNA3 will remain part of the fleet due to the age of the planes. There has also been some more positive news stories around the A380 recently, with emirates committing to fly them until 2036.

Wilbraham

You're braver than me! I've held since autumn 2013, luckily in a SIPP so it will just about wash its face if Emirates lease payments are maintained to end of term and there's nil residual value. Broadly that's what the market is pricing currently. (Actually that's no longer true - I've blown my LTA so dividends are now 'taxed'.)

I don't comprehend how an airframe can have a residual value of $50m in 2024, or even 25% of this. Surely no other operators will be buying extra A380s as it's a dead duck commercially and the prospect of it ever being converted to a freighter has been shot down. Emirates is currently operating 25% of its A380s but nearly 100% of its 777s. I gather Dr Pepper bought a couple of airframes pre-covid but the pandemic and very slow recovery in international travel has changed the market dynamics considerably (unless there were some weird way in which they would make sense of socially distanced travel at much reduced load factor). People talked of the airframes having part-out/break-up value but the engines are not I believe used in any other planes and almost everything will be bespoke to the A380. How many retired airframes will be required to support an ever-dwindling fleet? (Though I get that the more recent airframes should have greater utility for spares.) Possibly there will be greater life in the fleet than I've painted; after all, 747s are just coming to end of life after 50 years, though many were repurposed for cargo.

To me, the stronger hope for some residual value is a scenario in which covid is conquered, long distance travel takes off again, Emirates maintains the A380 as its flagship and a deal is done to extend one of more of the DNA3 airframe leases, perhaps on a rolling annual basis. Against that, there must be a non-trivial risk that Emirates does seek to renegotiate the leases before expiry - the July asset manager report has the sentence ''Additionally, the
carrier sought to restructure certain financial obligations, renegotiate contracts, and consolidate its operations''. I dodged a bullet on Amedeo Air Four Plus (LON:AA4) (sister company) which had leases to Thai Airways which apparently are up for renegotiation.

There's a dismal thread on pprune on the fall of the A380, updated sporadically https://www.pprune.org/rumours...

My understanding was that the major holders were long term income investing institutions rather than PIs - possibly they continue to hold for similar reasons to me, ie more in the hope, rather than expectation, that there'll be some meaningful residual value.

abtan

£DNA2

I can't provide as much insight into the residual values of A380's as the other 2 excellent posters here, but I will add that I bought into £DNA2 last year when:

Emirates payments looked secure;
therefore the future dividend payments from £DNA2 looked secure;
Remaining dividend payments were > the market value at the time that I purchased.

I would not, however, buy now as:

The remaining dividend payment of 59p is lower than the current share price (73p);
this final comment at the bottom of both the £DNA2 and £DNA3 quarterly reports spooked me:
"So far, only a limited secondary market has developed for the aircraft type."

Forgetting the very helpful chart the company provides with several scenarios, but if there's no secondary market, then the plane is being sold for parts.

I'll continue to hold for now as I still believe that the downside is minimal, but I probably wouldn't buy today.

Cheers

shamusj

27th Jul '21

Great commentary, thank you all. I found it valuable to hear your perspectives on this.

There is also this which is bullish:

Sir Tim Clark's statement on A380s

28th Jul '21

It looks like Schroders just bought in according to the TR1 today. Over 5% stake.

GrahamScott

M&G just announced purchase of 10% of the shares in Doric 3

29th Jul '21

This stock is attracting twice the average volume today and the trading day isn't even over. Has there been sentiment change over A380's, or is the outlook for aviation in general a lot more bullish than it was last week?

30th Jul '21

I don't think it's particularly high volume - bear in mind there are some days when there's next to no volume. The SP rot set in some time before covid when there was a growing realisation that the A380 has limited commercial future (hence negligible secondary market) orders were cancelled and production eventually ceased. SP fell to the 70s then covid was the final nail - at peak pessimism it fell below the outstanding target dividend payments presumably as people put some likelihood on Emirates seeking to renegotiate (after all, look how the commercial property market was affected!).

On a tangent, has anyone looked at the recent IPO Taylor Maritime Investments (LON:TMIP) It seems potential income generator if held tax-exempt, with target 10% pa return, including 7% pa dividend. They've bought a s/h seed portfolio of 23 smaller bulk carrier ships from their $200m raise that they will lease on 6-24 month (I think) contracts. A $75m placing followed soon after for another 6 ships - part of their talk of having a $500m pipeline of opportunities. Minimal debt.

Relative to the Doric stable there's a far more diversified customer base but no certainty of daily contract rates in the medium term (and freight rates have been volatile, especially recently, so perhaps we're on the crest of a wave?). Vaguely similar concept to Hipgnosis Songs Fund (LON:SONG) where they raise capital to buy music catalogs with little certainty on future royalty income and where the portfolio has to be actively managed.

The founders sound highly experienced but there's perhaps too strong a family connection for me to be comfortable, especially given the potential conflicts with the commercial and technical managers mentioned deep in the prospectus. There was no founder selling in the IPO. I managed to download the 180 page prospectus but can't link to it, so here's the recent factsheet https://taylormaritimeinvestme... Also a write up here https://citywire.co.uk/investm...

I can deal through Charles Stanley but not through interactive investor who say they're awaiting the KIID.

Doric Nimrod Three - A good risk/reward?

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Shamusj

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