That said, a spate of announcements from the company in the past month is very supportive and I would expect the ongoing rally to continue as investors warm to the merits of the investment case. Indeed, having initially raised $100m (£66m) from an unsecured five-year loan note issue at the end of May 2015, Avation’s board is successfully deploying the proceeds to fund the acquisition of a total of 10 aircraft by the end of June 2016 in order to take the fleet to 39 planes.
For instance, less than a month ago, the company successfully completed the purchase of a four year-old Airbus A320-200 leased to Air France, so diversifying the airline customer base and executing its strategy of building the portfolio. This is the sixth A320-200 plane the company owns. And yesterday, Avation delivered the second new ATR 72-600 aircraft to Flybe, one of a series of five new planes to be progressively delivered to the airline during the course of 2015 and early 2016. The aircraft is in the livery of Scandinavian Airlines (SAS) and will be operated by Flybe for SAS under an operational contract arrangement called the "white label" project. The lease rate and terms are typical for leases of this type; the initial lease duration is six years and the client has options for extending the term. Avation is now the second largest ATR leasing company worldwide, in terms of firm orders, having taken delivery of 25 ATR 72-600 aircraft since 2011.
In a separate announcement yesterday, Avation’s 97 per cent owned subsidiary, Capital Lease Avation (CLA), entered into a sale and lease back agreement to acquire a six-year old Airbus A320-200 for $34.3m (£22.4m). Completion of the transaction is due by the end of the year and funding will be from a $25m bank loan.
Fleet expansion
In aggregate, the 10 aforementioned aircraft deliveries, a mixture of Airbus A321 and ATR72 planes, and the Capital Lease transaction, have a total purchase value of $314m (£205m) and represent a 54 per cent increase in the value of the fleet. Funding will come from $109m cash on the company’s balance sheet and low-cost credit lines: Avation’s has an average cost of debt of 4.4 per cent on secured borrowings.
Of course, borrowings are high – Avation has a loan to value ratio of 72 per cent on its fleet - but this is the nature of the leasing industry, so it’s reassuring that almost 90 per cent of all borrowings are at fixed rates to mitigate interest rate risk. More important though is the quality of Avation’s client base and visibility of revenues.
On this score, the company scores well. Committed future revenue from unexpired leases on the current fleet of 29 aircraft was $369m at the end of June 2015 and Avation had also entered into lease agreements on eight of the new aircraft due to be delivered to the company before 30 June 2016. These new leases are scheduled to generate additional committed revenue of $196m over the terms of the leases which means that the total future lease revenue from the existing fleet and contracted deliveries is now around $564m. Moreover, with Avation earning a decent net return on these leases, then the company’s earnings will grow rapidly too.
Earnings growth trajectory
To put this into perspective, analyst Ian Berry at broking house W.H. Ireland expects Avation’s revenue to rise from $60m to $70.5m in the current financial year to end June 2016 to drive up pre-tax profits from $15.5m to $23.6m. On this basis, EPS rises from 26.1 cents (17p) to 38.4 cents (25.1p) and should enable the board to increase the dividend by 10 per cent to 3.3 cents (2.2p).
This means the shares are trading on less than 9 times historic earnings, falling to 6 times estimates for the current year, on a slight discount to book value of 151p, and offer a prospective dividend yield of 1.5 per cent. Most US peers are rated on between 7 to 11 times earnings estimates, according to Mr Berry, and none are expected to deliver the earnings growth of Avation. Mr Berry also predicts EPS will hit about 33p in fiscal 2017 based on a successful execution of the aircraft expansion.
Of course, there are risks to consider such as an economic downturn leading to a caution in the highly cyclical airline industry and dampening demand for new planes coming on stream. There is client default risk to consider too especially as Avation leases its planes to a small group of airlines including US Airways, Virgin Australia, Condor, Fiji Airways and UNI Air, the largest regional domestic airline in Taiwan. That said, the credit quality of these airlines is good, the company is successfully diversifying its client base, and when aircraft have been returned to Avation in the past the company has not had a problem either re-leasing or selling them on at their carrying value.
Target price
So with the shares rated on a modest single digit PE ratio, low-cost funding in place to complete the aircraft delivery schedule, and lease agreements in place with airlines, then I feel the company is being harshly rated considering the board are successfully executing the fleet expansion.
Interestingly, from a technical perspective, a daily close above the March and June highs of 155.5p would signal a confirmed break-out on the chart and one that would shorten the odds of a return to last autumn’s highs of 182p. It’s one that looks on the cards to me as we are guaranteed a flow of positive trading updates from the company in the coming months as new aircraft are delivered and leased out to the airlines.
On a bid-offer spread of 145p to 148p, I continue to rate Avation’s shares a medium-term buy offering potentially 35 per cent upside to my 200p target price.
Please note that I published four articles yesterday and another column today, all of which are included in the list of my articles below.
MORE FROM SIMON THOMPSON...
I have published articles on the following companies in the past three weeks:
■ Trakm8: Run profits at 195p, target 220p; Character Group: Run profits at 518p, target 575p; Marwyn Value Investors: Buy at 220p; Global Energy Development: Speculative buy at 30p; Software Radio Technology: Buy at 27p, target range 40p to 43p; Globo: Buy at 33p, target 69p; Pittards: Hold at 105p ('Cashed up for cash returns, 22 Sep 2015).
■ KBC Advanced Technologies: Buy at 112p, initial target 142p; K3 Business Technology: Run profits at 298p; Cenkos Securities: Buy at 177p; Netplay TV: Buy at 10p ('Small cap value plays', 23 Sep 2015).
■ Miton: Buy at 26.5p, target 35p; 32Red: Buy at 73.75p, target 90p; Stanley Gibbons: Buy at 138p; Vislink: Buy at 40p, target 70p ('Building momentum', 29 Sep 2015)
■ Moss Bros: Buy at 97p, target 120p; GLI Finance: Buy at 52p, target 80p; Town Centre Securities: Buy at 315p, target 350p; Globo: Buy at 39p, target 69p ('Platforms for success', 30 September 2015)
■ Safestyle: Run profits at 255p; Epwin: Run profits at 138p; Manx Telecom: Buy at 188p, target 210p ('Income plays with capital upside', 1 October 2015)
■ LXB Retail Properties: Buy at 86p, target 99p ('Bag a retail property bargain', 5 October 2015)
■ Creston: Run profits at 162p, target 171p; Fairpoint: Run profits at 184p, new target range 200p to 220p; Trifast: Buy at 114p, target 140p; 600 Group: Buy at 16p, target 24p; Renew Holdings: Buy at 315p, target range 350p to 375p; Stanley Gibbons: Hold at 105p ('Engineering ratings upgrades', 6 October 2015)
■ STM Group: Buy at 71p, target 80p ('Riding small cap winners', 7 October 2015)
■ First Property Group: Buy at 39.5p, target 49p ('In pole position for re-rating', 7 October 2015)
■ Tristel: Run profits at 99p, target 110p ('Cleaning up with superbug buster', 7 October 2015)
■ Equity market strategy ('Bull market pointers', 8 October 2015)
■ Gresham House: Buy at 320p, target 450p ('A mandate for strong growth', 12 October 2015)
■ Tristel: Run profits at 123p, new target 130p to 135p ('Cleaning up', 13 October 2015)
■ AB Dynamics: Run profits at 267p ('Under-promising, over delivering', 13 October 2015)
■ Trakm8: Run profits at 245p ('Motoring ahead', 13 October 2015)
■ PROACTIS: Buy at 102p, new target 130p ('Secured growth for re-rating', 13 October 2015)
■ Avation: Buy at 148p, target 200p ('Flying higher', 14 October 2015)
■ Cohort: Run profits at 400p ('Cohort on a roll', 14 October 2015)
■ 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 £2.95 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
