Having added five new aircraft to the fleet in the second half of 2015, the company has taken delivery of a further five new planes in the past three months to take its fleet to 39. Avation has also extended the lease of an Airbus A320 aircraft that was leased out to Air France last autumn. The acquisition of these aircraft are largely funded by bank debt and by utilising the $100m (£70m) of cash the company raised through a five-year bond issue in May 2015 and on which it's paying an annual coupon of 7.5 per cent.
The interest charge on that bond will subdue profits in the 12 months to the end of June 2016, but with a raft of new leases now in place analyst John Cummings at house broker WH Ireland forecasts a sharp step change in profitability in the new financial year. This explains why he expects pre-tax profit to almost double from $13.4m on revenue of $71m in the 12 months to the end of June 2016 to $25.8m on revenue of $103m in the 12 months to the end of June 2017. On that basis, expect EPS to rise from 22.2¢ to 40.5¢, or 28p at current exchange rates, to support a dividend per share of 3.6p. This implies Avation's shares are rated on a modest five times prospective earnings and offer a forward dividend yield of 2.5 per cent.
Those estimates look pretty solid to me once you factor in the contribution from five new aircraft that Avation has leased to airlines since I made a strong investment case at the end of February ('Aircraft deliveries mask Avation lift off', 23 Feb 2016). These include two new airbus A321-200 planes that have been delivered to Thomas Cook on a 12-year operating lease; another A321-200 aircraft that has been leased to Vietjet, the leading domestic and international new-age carrier in Vietnam; and two new ATR 72-600 planes that will be operated by Flybe on behalf of Scandinavian Airlines (SAS) under a six-year operational contract arrangement. The planes will operate in Scandinavia in the livery of SAS.
Sound business model
The forecast rise in profit is not only underpinned by the long-term nature of the lease agreements Avation has entered into, but by the fact that Avation's average lease yield of 13.4 per cent on its existing fleet is well ahead of its 4.9 per cent weighted average cost of debt. By my reckoning the company has an average remaining lease term of 6.5 years on its fleet which will generate around $600m of lease rental payments. I would also flag up that Avation aligns the lease term with the funding arrangement exactly and also fixes in the cost of debt to mitigate financial risk.
Importantly, all the aircraft are leased out to a diversified customer base that includes Air Berlin, Air India, Condor, Fiji Airways, UNI Air, and Virgin Australia. This broad client base mitigates risk of an operator defaulting on their lease agreement. The planes are pretty new too as the average age of the aircraft is just over four years.
Of course, by its nature the company is highly geared and analysts predict the company's net debt will rise from $420m to $609m in the second half ending 30 June 2016, or five times shareholders' funds of $122m. But with cash profit set to soar from $63m to $94m in the next 12 months, and total revenue from unexpired leases around $600m on Avation's existing fleet of 39 planes, then there is clear visibility of future income to service the debt and leave a tidy sum left over for shareholders.
Undervalued on a peer group basis
I would also flag up that the relative undervaluation of Avation is set to come into focus after this week's IPO on the Hong Kong Stock Exchange of BOC Aviation, the Singapore-based company that leases planes to 62 airlines around the world. The company raised $1.1bn (£758m) in this week's IPO at an offer price 1.2 times the company's 2015 post-money price-to-book ratio, according to analysts. BOC Aviation joins China Aircraft Leasing Group as the second aircraft lessor listed in Hong Kong. China Aircraft trades on a price-to-book ratio of 2.2 times and on 9.48 times estimated 2016 earnings. By comparison, Avation is priced on a 15 per cent discount to book value and on only five times likely earnings for the 2016-17 financial year. There is deep value here.
Interestingly, from a technical perspective a move above the 150p resistance level would signal a major chart break-out and narrow the odds for a move back to the 182p all-time high which dates back to November 2014. I wouldn't bet against it.
So with Avation's management team continuing to deliver on its fleet expansion programme, and the company lowly valued both in absolute and relative terms, I continue to rate the shares a buy and maintain my 200p target price. Buy.
