Clearly, the spread of Ebola is a worrying situation, and one that in no way would I ever attempt to downplay. But we have been here before with the SARs virus over a decade ago. Travel companies and the confidence of travellers recovered from that health scare and I expect the same to happen here too given the actions being taken to try to contain the disease's spread.
In the circumstances, this month's 10 per cent sell-off of the Aim-traded shares in commercial passenger aircraft leasing company Avation (AVAP: 143p) seems an overreaction. That's because the company buys new planes and immediately leases these out on an initial average term of 10 years to high-quality customers. So by matching the maturity of the credit lines being used to fund the aircraft acquisition with the term of the leases, Avation makes sure that there is no "through lease term" re-financing risk on its own borrowings. The company also only leases the planes out to high-quality customers, including US Airways, Virgin Australia, Thomas Cook, Condor, Fiji Airways and UNI Air, the largest regional domestic airline in Taiwan. Two-thirds of the company's portfolio of 27 planes are ATR 72 aircraft, and the balance are Airbus A320 family aircraft and Fokker 100s.
Importantly, business has not suffered. In fact, Avation has just announced the biggest deal in its history: a conditional agreement with Thomas Cook for the purchase and leaseback of two new Airbus A321 aircraft worth $100m (£62m). The two planes will be delivered from Airbus in the first quarter of 2016 and the lease agreements have an initial term of 12 years with an option for Thomas Cook to extend them for a further six years.
It’s a landmark deal as it moves the company into the jet market which is 50 times the size of the turboprop market where Avation has been specialising in since its formation eight years ago. The company has a pre-delivery finance programme in place to fund the aircraft which are being leased out on commercial rates. To put the size of the transaction into some perspective, analysts calculate that it equates to a “20-25 per cent increase in assets, revenues and earnings compared to the 2014 fiscal year”. In a full-year, the two aircraft will generate $3.8m profits for Avation which is significant in relation to the company’s pre-tax profits of $16.6m in the fiscal year to June 2014.
And that’s not the only announcement Avation has made. It has also increased its shareholding in Aim-quoted subsidiary Capital Lease Aviation (CLA: 20p) to 95 per cent and I would expect in due course the company to be delisted. The acquisition enhances Avation’s earnings per share and is accretive to net asset value per share too. The boost to its balance sheet should also enable the company to borrow on better terms too.
I also note that Avation has changed its depreciation policy and will now depreciate its new planes on a 25 year basis, five years fewer than previously, using a residual cost of 15 per cent of the purchase price at year 25. Second hand aircraft will be depreciated from 25 years from manufacture to estimated scrap value based on third party appraisers’ values. It’s a sensible move as it brings Avation’s policy in line with that of other aircraft leasing companies. And it will have no profit impact as reducing the depreciation term is offset by the higher residual value.
Impact on earnings
As a result of the Thomas Cook sale and lease back and the ramp up in the fleet on the back of new aircraft deliveries, analysts now expect Avation’s adjusted EPS to rise from 27.4¢ to 34.9¢ (22p) in the current fiscal year to June 2015, increasing to 40.9¢ (25.5p) the year after. That represents a 10 per cent earnings upgrade for fiscal year to June 2015. For a company set to grow EPS by 50 per cent over a two year period, I still feel that a prospective PE ratio of a little over 6 is harsh. There is a small dividend too as the board declared a payout of 2¢ last financial year and this is predicted to rise by 10 per cent annually this year and next, implying a forward PE ratio of 1 per cent.
So although the shares have been caught up in the Ebola scare and the general market rout since I advised buying at 159p six weeks ago (‘Get on board for blue sky gains’, 11 September 2014), I feel investors have overreacted in this case. Priced in line with net book value, against a sector average premium of 10 per cent, and with significant potential upside to earnings from the company’s options on 26 new ATR aircraft, I see the current valuation as attractive and reiterate my 200p target price. Trading on a bid-offer spread of 140p to 143p, I continue to rate Avation shares a buy.
Please note that I have written three specific articles on financial markets in the past week, all of which are available on my home page:
Equities: Eurozone growth scare spooks investors (13 October 2014)
Monetary policy: Normalisation is coming so plan ahead (17 October 2014)
Bond markets: Lessons to learn from bond market flash crash (17 October 2014)
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
